Verit View – June 2018
Middle Market M&A: It’s More Than Just Identifying the Buyer
We all know that M&A is about finding the best buyer. Verit Advisors’ view is that preparation and process are critically important to finding and closing the best buyer. The M&A process, whether it involve an ESOP, PE, or strategic buyer, takes time, expertise, and extensive legal and financial due diligence that strains management. Too often, companies are under-prepared for the intense level of focus and scrutiny involved in transaction execution. The excitement of receiving a strong LOI can dissipate to adversarial rapport and distrust (and sometimes a failed deal). We believe prior preparation mitigates this acrimony.
- Quality of Earnings: We recognize it’s painful to take on yet another expense. But please bear with us. For those who are unfamiliar with the terminology “QofE,” a Quality of Earnings report is a detailed analysis conducted by an independent third party firm of all of the components of a company’s revenue and expenses. A QofE confirms historical and pro forma earnings as well as projected non-recurring addbacks. Addbacks add up. They are the expenses or adjustments the business will no longer incur with a new owner. A QofE confirms management addbacks to free cash flow or EBITDA and provides insight into additional addbacks or deductions to value that a buyer may try to negotiate. Additionally, knowing the buyer’s “playbook” (the buyer will likely have its own Qof E report) creates a stronger negotiating position for the seller, arming the seller with detailed evidence confirmed by a third party.
- Role of an Investment Banker: We recognize it sounds trite when an iBanker recommends using an investment bank. Respect the saying “you get one chance at a first impression.” You want to look your best to the market. It is crucial to the overall success of the process to take time at the front end of the deal. Key activities include mapping out pre-transaction diligence, vetting buyers and a customized approach, designing negotiation strategies for each buyer, establishing deadlines and a controlled process, etc. An experienced investment banker will lead you through this process. An investment banker also provides support to management to navigate the demands of an M&A process. A qualified investment banker makes a statement to the buyer universe that you are serious about selling. Buyers don’t want to invest the time and money with a seller that isn’t committed. Your ideal investment banker will be candid and forthright, pointing out potential buyer-perceived gaps, which can be addressed prior to going to market. A good partner will also tell you if it is not a good time to sell due to company-specific or macro related issues.
- Business Plan and Projections: While management might have identified multiple avenues for future growth, it is important to divide growth initiatives into short-term and long-term horizons. Buyers will want to examine the profitability and costs of any short-term growth initiatives and the ability to execute these plans quickly. Thoughtfully refining the business plan and projections can help hone a potential buyers list and provide insight into those more likely to pay a premium for potential synergies. Well-developed financial projections include management’s best estimates including rational growth initiatives. Potential buyers will want to see how a business is tracking to the financial projections. Beware, you want to hit or exceed your projections during the marketing process. Negative earnings outcomes give excessive negotiating leverage to a buyer, which can derail a deal.
Executing an M&A transaction is a time intensive and incredibly thorough process. While this might seem daunting to some middle market companies, Verit Advisors’ view is that preparation and diligence prior to an M&A process strengthens the seller’s negotiating leverage leading to increased value and a smoother process.
As always, it is Verit’s vision to bring a fresh approach and customized solutions to advise private business owners on ownership transition.