The Art of M&A, Fifth Edition: A Merger, Acquisition, and Buyout Guide

By Alexandra Reed Lajoux and LLC Capital Expert Services

Make every deal a major win! The M&A classic has been updated for today’s business landscape Since the last edition of this authoritative resource was published, the M&A world has gone from boom to bust and back again—and this new edition brings you completely up to date. With critical lessons learned from the financial crises and regulatory shocks of the past decade, The Art of M&A, Fifth Edition delivers the information and insight you need to make all the right decisions throughout the process. Learn the ins and outs of: •Getting Started—basic process, requirements, and objectives • Strategy—deciding what to buy and why •Valuation and Modeling—measuring and projecting value pre- and post-merger • Financing and Refinancing—sourcing capital • Structuring—mitigating financial, tax, and legal risk • Due Diligence—investigating a business’s past, present, and future risks • Documentation and Closing—pulling everything together to ensure a smooth transaction • Integration—merging resources, processes, and responsibilities to maximize synergies • Landmark Cases—legal cases you need to understand The Art of M&A is an indispensable resource for anyone heavily engaged in the process—whether you’re an executive tasked with growing your businesses, an investment banker structuring transactions, an attorney responsible for due diligence, or an accountant who advises buyers and sellers. Turn to this definitive resource to develop, steward, and close deals that benefit everyone involved.

• Language: English
• Publisher: McGraw-Hill Education
• Release date: Jul 19, 2019
• ISBN: 9781260121797

Book preview

PREFACE AND ACKNOWLEDGMENTS

There are no foolish questions, and no man becomes a fool until he has stopped asking questions.

—Charles Proteus Steinmetz (1865–1923)

The past decade has been a virtual roller coaster for mergers and acquisitions (M&A). After soaring into the pre-Crisis peak of 2007, global deal activity slumped—particularly when measured in dollar terms—for the next several years, even as the US equity markets rallied back from their Crisis lows. Deal appetites improved toward the middle of the current decade, as CEO confidence firmed and the economic rebound gradually spread to other parts of the world, with 2018 bringing in a strong year for M&A, especially for mega-deals. The year saw only 48,000 announced transactions (down 7 percent from the previous year) but raked in deal value of more than $4 trillion (up 19 percent from the previous year).

But while M&A volumes and values will ebb and flow from year to year, Exhibit A-1 underscores that the overall trend during the past 30 years has been an ever-higher march forward—reflecting the economic reality that M&A is here to stay as a permanent fixture in the corporate finance landscape.*

Exhibit A-1   Global M&A Activity

Source: Institute of Mergers, Acquisitions & Alliances (IMAA), 2019

What’s driving this recent resurgence in consolidation activity? How has dealmaking changed in the past decade? For example, how have innovations in financial technology (fintech) affected the M&A process?

The Art of M&A: A Merger, Acquisition, and Buyout Guide, Fifth Edition, attempts to provide accurate, practical, and up-to-date answers to these and another 1,000 questions that dealmakers—spanning investment bankers, lawyers, accountants, consultants, boards of directors, and business managers and owners, among other constituents in the M&A process—may have in this new environment. Like its four predecessors, the fifth edition is organized in its trademark question-and-answer format, moving from general to specific questions in each topic area. Feedback from more than 30 years of readers overwhelmingly supports this unique format as a user-friendly way to convey material to beginners without sacrificing the in-depth research valued by learned industry professionals. That The Art of M&A’s unique question-and-answer format is still so widely celebrated after 30 years is a testament to the foresight and vision of our founding author, Stanley Foster Reed.

What is your burning question of the moment? It may be as basic as What is a merger? or it may be as arcane as After a Section 338 acquisition, must the purchaser retain the acquired company as a subsidiary? Whatever you want to know, you are likely to find the answers here—or at least a useful source reference.

Building upon its Socratic roots, and reflecting inevitable changes in how industry professionals and business constituents approach research, the fifth edition also takes a step in a new direction—the 2019 edition includes more diagrams, case studies, and references to web-based and other electronic resources—all the while honoring the wisdom embedded in our introductory quote: There are no foolish questions, and no man becomes a fool until he has stopped asking questions.

ACKNOWLEDGMENTS

The Art of M&A first saw the light of day some three decades ago as the joint effort of founding author and serial entrepreneur Stanley Foster Reed and a law firm, Lane & Edson. This new edition still retains much of the timeless expertise of Lane & Edson attorneys and many other experts cited in the earlier editions. The following acknowledgments emphasize contributions to this fifth edition.

Capital Expert Services, LLC

This think tank and consultancy, founded in 2016, is dedicated to helping law firms and other professional services firms find the most qualified expert witnesses or consulting experts in areas outside the ordinary. CapEx is jointly owned by John Hotta, special advisor to this edition, and Alexandra Lajoux, lead author. Most of the experts consulted for this fifth edition and named below are part of this network of specialists. This book is dedicated to the CapEx Strategic Advisory Board. For more information visit capitalexpertservices.com.

Board of M&A Standards

In addition, it is an honor to include expertise of the members of the Board of M&A Standards (BMAS), a group of executives and advisors developing standards for M&A education. For additional information, see www.mastandards.com. Alexandra Reed Lajoux recently retired from the board and now holds emerita status. Current members of the board, whose specific contributions to this edition will be noted in endnotes, are as follows:

Jim Jeffries, Founder, BMAS. Jim is co-founder of the M&A Leadership Council, a global organization delivering best-practice training to the M&A community for the past decade. He spent 25 years leading consulting companies in performance improvement, private equity, and M&A, providing advice to Fortune 1000 C-level executives on valuations for M&A transactions that spanned values from niche players to $20 billion-plus multinationals.

Bill Blandford, Manager of M&A, Retired, Nokia. Bill has participated in over 50 transactions including the de-merger of Motorola, which led to the creation of two separate companies within Motorola. He successfully integrated more than 25 acquisitions and led the divestiture of 15 businesses. Bill also has extensive experience in divestitures, spin-offs, and internal reorganizations across the globe, with a primary focus on information technology (IT).

John Christman, Vice President of Corporate Development & Global Head of M&A Integration, Cognizant. John has 25 years of experience leading business transformation, including executive-level positions at Dell Inc., where he built and led global cross-functional programs and postmerger integration management teams as well as finance organizations. He has led a variety of teams focused on integration issues, from strategy to postacquisition integration planning and cross-functional integration.

Anthony Enlow, Partner, Transaction Advisory Services, BDO. Tony has over 15 years of experience providing financial due diligence and transaction advisory services. He has worked on over 300 transactions ranging in size from $5 million to $40 billion and has assisted buyers and sellers that include private equity, public, and private companies focused on transactional quality of earnings, cash flows, and working capital.

Dr. Bruce Fleming, Executive Vice President of Strategy & Growth, Calumet Specialty Products. A noted business executive and competitive strategist, Bruce directs internal and external growth initiatives including alliances, acquisitions, and targeted divestitures for Calumet. He has held senior business development and planning roles with Amoco Oil, Orient Refining, and Tesoro Corporation, where he directed acquisition of BP’s Carson (CA) refinery, including Federal Trade Commission (FTC) approval of this transaction, which Barron’s noted as Acquisition of the Year for 2012.

Len Gray, Global Head of M&A, Retired, Mercer Consulting. Len spent 30 years at Mercer in a variety of leadership roles in the United States and the Asia-Pacific region, including serving as the head of Mercer’s international M&A practice. Len provided talent management, human capital strategy, cultural integration, and leadership development consulting services to Mercer’s clients during mergers, acquisitions, divestitures, and new business initiatives.

Jennifer Lee, Vice President, McKesson Corporation. Jennifer established McKesson’s Corporate Integration Office, which has been engaged in over $25 billion in acquisitions since inception—including direct oversight of the IT workstream for a major healthcare transaction. She has led integration and divestiture/carveout teams and served as program/project manager and relationship manager.

Ellen Owens Karcsay, Director of Business Transformation, Avnet. Ellen directs business change at Avnet, a global technology company with abilities that can support the customer from concept through creation and design to distribution. In her current role, Ellen leads highly collaborative global business transformation initiatives that result in growth opportunities, cost savings, and process efficiencies. Most notably, Ellen served as the global lead for the divestiture of a significant portion of the Avnet business in 2016–17.

Dan Menge, former Director of M&A Integration & Corporate Development, Cisco; currently Head of M&A Integration and Corporate Development at Xilinx. Cisco as a company is widely recognized as being both highly acquisitive and successful in driving growth and transformation via inorganic activity. As leader of the M&A Integration Lead team and integration management office at Cisco, Dan led and engaged in over 60 transactions, ranging from multi-billion-dollar acquisitions to point product and talent deals to strategic divestitures. He also contributed to building Cisco’s scalable, industry-leading, workstream-based Acquisition Integration methodology. Today Dan is Head of M&A Integration at Xilinx, a leading fabless semiconductor company—one that designs and sells devices while outsourcing fabrication to a trusted foundry.

Wendy Parkes, Managing Director of Human Resources, Global Acquisitions and Divestitures, BMO Financial Group, Retired. Serving in London, Wendy led Global Acquisitions and Divestitures (A&D) for BMO Financial and created a new center of expertise (COE) for all M&A, A&D, and human resources (HR) related activities. She created the strategy, vision, principles, standards, operating model, and practices that are now used in all deals for BMO, including acquisitions, divestitures, and outsourcings.

Sue Rider, Vice President of Global M&A Integration, World Fuel Services. Sue is an HR leader with over 30 years’ experience in more than 35 M&A transactions spanning Europe, Asia, and the Americas. She led due diligence and integration for 23 strategic acquisitions, with a particular focus on organization design, talent retention, communications, change management, and compliance.

In addition, chapter by chapter, the following sources are notable:

Chapter 1, Getting Started in Mergers and Acquisitions, still contains wisdom from the many experts cited in previous editions. Chapter 2, Strategy, also draws from the legacy editions, but is primarily informed by Dr. Ken Smith, Managing Partner, Dundee Associates Limited, and lead author of The Art of M&A Strategy, a title in the Art of M&A series. Dr. Christopher Kummer, President, Institute for Mergers, Acquisitions, and Alliances, generously provided permission to include IMAA graphics depicting M&A activity. Charles Re Corr and Clark Abrahams, authors with the National Association of Corporate Directors, provided a model for decision making. Michael Nall, President, Alliance of M&A Advisors (AMAA), Chicago, Illinois, and Diane Niederman, AMAA Vice President of Alliances, advised us on the ever-important role of brokers and finders, especially for emerging growth companies. Also instrumental in reviewing the chapter was Dan Menge, Senior Director and Head of M&A Integration at Xilinx, and past Director of M&A Integration & Corporate Development, Cisco. Adam Epstein, Principal, Third Creek Advisors, provided insights on small-cap issues. Rob Baker, Founder, TeqAcq, advised on broker issues. Dr. Bruce Fleming, Executive Vice President of Strategy & Growth, Calumet Specialty Products, provided a case in antitrust approval as well as a discussion of predeal antitrust issues. H. Peter Nesvold, past managing director of Silver Lane Advisors, now part of Raymond James Financial, Inc., provided helpful comments on this chapter. As noted earlier, Peter was a coauthor of the fourth edition of this book.

Chapter 3, Valuation and Modeling, still benefits from the expertise of Al Rappaport, Principal, The LEK/Alcar Consulting Group, La Jolla (CA), and other experts cited in previous editions. In this edition, special thanks go to Nitin Kumar, Chairman, CyberSky Holdings, and Past Senior Managing Director, FTI Consulting, for reviewing the section on valuation of artificial intelligence; to Mike Adhikari, founder of ValueXpress, for conversations over the years; to Vladimir Antikarov, Principal, Vera Group, LLC, for his writings on real option value; to BDO’s Tony Enlow for comments on quality of earnings; and to Paul Chan, founder Malaysian Alliance of Corporate Directors, for the discussion of International Valuation Standards. Ken Hoganson, founder of the Private Directors Association and past President of the Chicago Chapter of the Association for Corporate Growth, offered insightful comments on the importance of negotiation as an aspect of valuation. A major source for this chapter was The Art of M&A Valuation and Modeling (McGraw-Hill Education, 2016), by H. Peter Nesvold, Elizabeth Bloomer Nesvold, and Alexandra R. Lajoux. This chapter also draws from a book Lajoux coauthored with Robert A. G. Monks, Corporate Valuation for Portfolio Investment (Wiley, 2011). The philosophy and writings of Bob Monks have had a profound impact on these pages.

Chapter 4, Financing and Refinancing, owes its greatest debt to the wisdom of the late J. Fred Weston, Cordner Professor of Money and Financial Markets at the University of California, Los Angeles. With Alexandra R. Lajoux, he coauthored another book in this series, The Art of M&A Financing and Refinancing: Sources and Instruments for Growth (McGraw-Hill, 1999). Also instrumental in creating this chapter was Dennis Roberts, coauthor with Lajoux of The Art of Bank M&A (McGraw-Hill Education, 2012). Dr. Heath P. Tarbert, currently Assistant Secretary of the Treasury, deserves credit for the early contributions he made to the financing material contained in that book. Francis Byrd, Managing Partner, Alchemy Strategies Partners, LLC, advised on the role of institutional investors in financing.

Chapter 5, Structuring Transactions: General, Tax, and Accounting Considerations, owes its greatest debt to Michael J. Kliegman, who provided the original answers to most of the questions here when he was an attorney at Lane & Edson, and who reviewed and improved this entire chapter. He is currently Senior Counsel at Akin Gump Strauss Hauer & Feld LLP in New York. Another key reviewer of this chapter was Dr. Solange Charas, founder, Charas Consulting. Dr. Charas provided detailed commentary on all compensation material in the chapter. This edition also remains indebted to experts cited in previous editions of this book, including Jack S. Levin, a longtime coauthor with the late Martin Ginsberg of the multivolume book Mergers, Acquisitions, & Buyouts: A Transactional Analysis of the Governing Tax, Legal & Accounting Considerations (Wolters Kluwer Law & Business, 2009). Professor Levin is both a Lecturer at the University of Chicago Law School and a Senior Partner with Kirkland & Ellis.

Chapter 6, The Due Diligence Inquiry, benefits greatly from the expertise of Charles M. Elson, Corporate Director and Director of the John L. Weinberg Center for Corporate Governance at the University of Delaware, coauthor with Alexandra Lajoux of The Art of M&A Due Diligence (McGraw-Hill Education, 2000, 2010). This chapter has a checklist that includes elements suggested by Dan L. Goldwasser, of Vedder Price Kaufman & Kammholz. Dialogue with Dr. Sri Ramamoorti, Partner, Grant Thornton, was also instructive. Professor Dana Kamenstein of the University of Pennsylvania’s School of Education provided insights on diagnosing corporate culture. Chapter 7, Negotiating the Letter of Intent and Acquisition Agreement, and Chapter 8, Closing, build upon the basic wisdom of the original edition, but include updates from the author and guidance from attorney Michael Kliegman, mentioned earlier as a reviewer of Chapter 5. Our discussion of smart contracts in the introduction to Chapter 7 builds on conversations with Marti Tirinnanzi, President, Financial Standards, Inc., and author Peet van Biljon, CEO and Founder, BMNP Strategies, LLC.

Chapter 9, Postmerger Integration and Divestitures, is adapted from Alexandra Lajoux, The Art of M&A Integration (McGraw-Hill, 2006), and subsequent updates of that material in other publications of the author. As such, the chapter owes a debt to the experts quoted in that book. Of special note is the author of the foreword to this book, Jim Jeffries, as well as all his colleagues at the M&A Leadership Counsel, especially John Bender, Larry Dell, Mark Herndon, and Jack Prouty. This chapter also draws from the work of Dr. Sanjai Bhagat, a thought leader with valuable perspectives on postmerger performance. Insights into deals from hell are inspired by the M&A guru Robert Bruner, Dean Emeritus, Darden School of Business, University of Virginia. The following corporate directors and board advisors, all prominently affiliated with the National Association of Corporate Directors (NACD), were influential in informing the board-related material in this chapter: Dr. Urmi Ashar; Thomas Bakewell, CPA; Dennis Beresford; Marty Coyne; Dr. Nina Dixon; Fay Feeney; Michele Hooper; James Lam; Shep Pryor; Charles Re Corr; Hal Shear; Dr. Ernie Smith; John Stout, Esq.; Dr. Larry Taylor; and Craig W. White, Esq. Ken Daly, past CEO of NACD, and Peter R. Gleason, current CEO, in addition to past NACD leaders Dr. Roger Raber and John Nash, brought governance insights to this section of the book. This chapter also benefits greatly from the expertise of John Hotta, a corporate director and retired Microsoft executive now serving as Cofounder and Board Member of Capital Expert Services, who read the entire chapter for its technological relevance. Thanks also go to Jennifer Lee, Vice President, McKesson, and to Ellen Owens Karcsay, Director of Business Transformation at Avnet, for the section on change management. Professor Antonio Nieto-Rodriguez offered wisdom on M&A project management. Also contributing were Sue Rider, Vice President of Global M&A Integration, World Fuel Services, on global HR; and Wendy Parkes, Managing Director of Human Resources, Global Acquisitions and Divestitures, BMO Financial Group, Retired. Last but not least, Bill Blandford, Manager of M&A, Retired, Nokia, provided experienced commentary on divestitures. Ethical guidance informing this book came from Dr. Jacques Cory of Haifa University in Israel; Stephen Jordan, Co-CEO, IO Sustainability; Dr. Lester A. Myers, Professorial Lecturer, Georgetown University; and Stephen R. Young, Esq., Executive Director, the Caux Round Table for Moral Capitalism.

Chapter 10, Special Issues for M&A in Public Companies, as well as Chapter 11, Workouts, Bankruptcies, and Liquidations, owe a general debt to the many major law firms that keep the author and expert reviewers educated on trends in securities law, bankruptcy law, and legal trends in general. Their legal briefs are cited throughout this book. Chapter 10 features the knowledge of Robert D. Ferris, Corporate and Investor Relations Counsel, who has shaped best practices for the investor relations community through volunteer leadership positions at the National Investor Relations Institute. This chapter also benefits from the expertise of Francis G. X. Pileggi, Partner and Vice Chair of the Litigation Group at Eckert Seamans Cherin & Mellott, LLC, in Delaware, who has graciously allowed the author to cite his material extensively in this chapter and throughout the book.

Chapter 11 benefits from the expertise of Jeff Anapolsky, who joined the author and H. Peter Nesvold to write The Art of Distressed M&A (McGraw-Hill Education, 2011). Thanks also go to Deborah Hicks Midanek Bailey, a veteran in turnarounds, who reviewed this entire chapter for relevancy and accuracy; John Collard, Chairman and CEO, Strategic Management Partners, Inc., whose writings have been influential; and Howard Brod Brownstein, Founder, The Brownstein Corporation, who advised on certain terminology. Chapter 12, Global Deals: Structuring for Success, owes its greatest debt to the two Lane and Edson attorneys who helped shape the original book. For tax review, we credit Michael Kliegman, Senior Advisor, Akin Gump. For other topics, we sincerely thank Ken August, Owner, August Law Group, PC, who was involved in the original edition. Also of assistance here: Paul Chan, Cofounder, Malaysian Alliance of Corporate Directors; Lew Lederman, QC, CEO, Knowledge E*Volutions, Inc.; Raoul Schuddeboom, Director, Corporate Advisory Services, Eurasia Group; Ka-Yin Li, Advisor, Hong Kong Institute of Directors; Anthony Riha, Partner at Advanced Technology Solutions (Asia); Rocky Lee, King & Wood Mallesons, Beijing China; Van Kirk Reeves, Reeves & Porter, an international law firm based in Paris, France; and Riccardo Trigona, an attorney in Milan, Italy.

In addition to the names listed earlier, the following individuals are acknowledged for their impact on M&A and corporate governance: Gerald Adolph, author of Merge Ahead: The Five Enduring Trends of Artful M&A (McGraw-Hill Education, 2009); Roger Aguinaldo, Founder, The M&A Advisor; Dr. David Anderson, founder and CEO, the Anderson Governance Group; Howard Bailen, veteran publicist; Hank Boerner, Chairman and CEO, Governance and Accountability Institute; David Brown, Executive Director, KPMG Board Leadership Center; Douglas Chia, Fellow, Center for Corporate Law and Governance, Rutgers Law School; Dr. John Coughlan, Founder and Director, CPA School of Washington; April Thurmond Dumas and Melissa Foster Follis, M&A Leadership Council; Allan Grafman, CEO, All Media Ventures; Holly Gregory, Esq., Partner, Sidley Austin, LLP; Pamela S. Harper, CEO, Business Advancement, Inc.; James Hatch, President, Oleum Technology, LLC; Debra Santini Hennelly, Founder, Resiliti; Gary Lutin, Chairman, The Shareholder Forum; Edith Orenstein, Manager, PricewaterhouseCoopers; Mike Lovdal, Emeritus Partner, Oliver Wyman; Jon Lukomnik, Managing Partner, Sinclair Capital; Jon J. Masters, Member, Private Sector Advisory Group, Global Corporate Governance Forum, International Finance Corporation; Ira M. Millstein, Esq., Senior Partner, Weil Gotshal & Manges, LLP; Cary Nicholson, Bank Examiner, Office of the Comptroller of the Currency; Gene Panasenko, Financial Advisor, Moloney Securities Co., Inc.; Michael Pocalyko, CEO, SI; Jeffrey Possinger, Managing Member, Possinger Law Group, PLLC; James Reda, Managing Director, Executive Compensation, Arthur J. Gallagher & Co.; Matthew Scott, Past Editor, Corporate Secretary Magazine; Dean Shaw, Managing Director, Shaw & Sullivan, PC; Brendan Sheehan, Vice President, Moody’s Investors Service; and Gabe Shawn Varges, Partner, HCM International.

The legal case summaries at the end of this book come from previous editions, but include updates based on the writings of Francis G. X. Pileggi, cited earlier.

In closing, the author extends sincere thanks to the top-notch professional editorial and production team at McGraw-Hill Education that made this book possible, including Noah Schwartzberg, Senior Editor, Business; Ami Li, Editorial Assistant; Donya Dickerson, Editorial Director; and Christopher Brown, Publisher. Working with the team, Ginny Carroll of North Market Street Graphics (NMSG), provided excellent copyediting and project management services. Thanks also go to the other key players on the NMSG team: painstaking compositor Mark Righter, and eagle-eyed proofreaders Mike Dunnick and Stewart Smith. Our careful indexer was Erika Millen. Also deserving thanks is Chris Smith of Quarternative.com, who provided many of the exhibits in this book. Finally, we thank Cal Hunter, Manager, Business Development and Business Department, Barnes & Noble, 555 Fifth Avenue, New York, for his belief in this book.

* For a detailed report on trends, see Thomson Reuters League Table reports at https://financial.thomsonreuters.com/en/products/data-analytics/company-data/investment-banking-league-tables.html. See also http://dmi.thomsonreuters.com/content/Fiiles/4Q2018_MNA_Financial.

CHAPTER 1

Getting Started in Mergers and Acquisitions

A little learning is a dangerous thing;

Drink deep, or taste not the Pierian spring;

There shallow draughts intoxicate the brain,

And drinking largely sobers us again.

Alexander Pope

An Essay on Criticism

INTRODUCTION

Perhaps nowhere else does Pope’s maxim prove truer than in the area of mergers, acquisitions, and buyouts. The purchase or sale of a business enterprise is one of the most challenging transactions—indeed, journeys—one can undertake. And the wise traveler should set off on this journey for the right reasons—for the most common catalysts to doing a deal can also be the most ill-fated. Consider the business owners who want to revolutionize their technology without realizing that they are in the wrong business to begin with—or are going about it the wrong way.

And beyond the boardroom debate about whether to do an acquisition of some type is the issue of how the potential transaction is actually structured. Not only does an M&A deal cut across countless securities and tax laws, accounting rules, and regulatory requirements, but it also has the potential to either reinforce, or disrupt, the cultural underpinnings of the buyer or seller. Key intangibles—such as the cultural alignment and logistical integration of two previously disparate organizations—win or lose deals. They can be the determining factor in whether an otherwise well-structured merger or acquisition ultimately harvests its intended benefits and builds long-term value. As such, M&A can be a make-or-break decision for many executives of major corporations; likewise, the sale of a business can be a once-in-a-lifetime realization event for many small business owners. In both cases, the players must know what they are doing.

More than 50 years ago, in the fall of 1965, Stanley Foster Reed, the original author of this book, launched the first issue of Mergers & Acquisitions magazine. He prefaced the magazine, which continues to this day via the SourceMedia platform,¹ as follows:

Dedicated to the Ever-Renewing Corporate Society

As we take part in this third great wave of merger and acquisition activity in America, we are struck by the rate of economic growth, and by the speed with which corporations are merging and being formed. Research indicates that at present rates, one out of every three corporations will either merge or be acquired during the next ten years. This makes change the condition by which we grow and develop.

Each day here in the United States one thousand new businesses are born. Some drive for the heights like a great Fourth of July rocket and end in a burst of color—a hasty life, beautiful but short. . . . A few, carried on a quick tide of youthful energy and special knowledge, will grow great and strong and eventually wise and will become a shelter for the less strong and the less wise.

This is the ever-renewing corporate society.²

As Reed’s prologue shows, Mergers & Acquisitions magazine was founded with one clear goal in mind: to show buyers and sellers of companies how to create strategies—and shelter—for continual growth in a world of constant change.

Reed had this same purpose in mind when he teamed up with the law firm of Lane & Edson, PC, to produce the first edition of this guidebook in 1988, the height of the LBO movement, as romanticized by the character Gordon Gekko in Oliver Stone’s unforgettable movie Wall Street. The L&E attorneys shaping the first edition of this book were really there on the front lines of M&A change, advising buyout kings like former Treasury secretary William E. Simon and Ray Chambers, founders of Wesray. The first edition of the big book featured Reed as coauthor and Alexandra Reed Lajoux, his daughter, initially as project manager.

The 1988 text was an instant classic, but as deal structures shifted under the weight of hundreds of legal precedents, temperamental financing markets, and constantly changing accounting and tax rules, a major revision in the original text proved necessary. Subsequent editions by Reed and Lajoux followed in 1995 and 1999, as did a series of spin-off titles, exploring each of the major topics in greater depth. H. Peter Nesvold joined the series in 2001, serving as coauthor of not only three special titles in the series but also most notably as coauthor of the fourth edition with Reed and Lajoux. That edition was published in 2007—shortly before Reed passed away at age 90, his mission accomplished. As detailed in the front matter to this book, the current edition contains the wisdom of countless professionals dedicated to M&A—including experts associated with Capital Expert Services, LLC, coproducer of this edition.

To state the obvious, much has changed over the past decade. This fifth edition continues the legacy of the original book and the broader Art of M&A series, capturing key trends and technical changes that have occurred over the 10-plus years as the M&A arena suffered through a global financial crisis and emerged with new, sometimes painful, lessons learned. Yet Reed’s vision from 50 years ago of M&A as central to an ever-renewing corporate society remains as true today as it did in 1965.

Every year trillions of M&A dollars change hands globally—not only in the purchase of huge companies or of major interests in them, but in the tens of thousands of smaller companies that are bought and sold from Peoria to Paris. As we go to press, M&A remains very much a part of the global economy. As illustrated in Exhibit A-1 in the Preface to this book, dealmakers closed M&A transactions worth more than $4 trillion globally in 2018. Aggregate global M&A transaction values have recently more than doubled off their Crisis lows of 2009; what’s more, recent annual values have increased nearly fourfold from 2002’s cyclical lull and have soared more than 13 times over since 1985. Even considering the multiplier effect of inflation,³ the growth is still obvious. (See Exhibit 1-1.)

Exhibit 1-1   Global M&A Transaction Value (1988 vs. 2018)

Source: Institute of Mergers, Acquisitions & Alliances (IMAA), 2019.

To be sure, this decade’s resurgence in M&A activity will eventually come to a pause; there will always be cyclical highs and lows in deal volume, driven by myriad forces explored throughout this book. But just as that pause is inevitable, so too will it prove temporary. M&A clearly is here to stay: the buying and selling of companies remains a key option for many companies seeking to enhance growth or to harvest value created. Yet we can’t emphasize enough how complex and dangerous the merger process can be. A great deal of hard-earned value is at stake in any transaction, and while there are success stories, there are also deals from hell, in the words of Robert Bruner, dean emeritus of the Darden School of Business.⁴ Often divestiture is the cure.

To strike lasting deals, acquirers and sellers—both large and small—must drink from the ever-renewing spring of M&A knowledge. To drink deep, they must recognize first that there is something called an acquisition process, with many crucial stages and many key players. To carry out any one stage well requires solid grounding in the entire process, which typically unfolds in the following phases (see Exhibit 1-2):

Exhibit 1-2   The M&A Process

   Strategy Phase—Deciding whether, and if so how, to buy or sell whether as a strategic buyer or a financial buyer

   Valuation Phase—Determining the value of the company to be bought or sold

   Financing Phase—Obtaining the funds, internal or external, to make the deal happen

   Structuring Phase—Making the proper accounting, financial, legal, and tax designations for the transaction

   Due Diligence Phase—Verifying that the company is what it claims to be and discovering risk exposures material to the transaction

   Negotiation Phase—Convincing the other party to agree to your terms without jeopardizing the deal

   Closing Phase—Consummating the transaction, thereby making it official

   Integration Phase—Managing postmerger operations through stand-alones, integration, and/or divestiture

As these eight key chapters show, the M&A journey involves exploring the answers to many serious questions. First, an acquirer needs to ask if it should remain independent, buy another company, or sell to another company. Does combining two particular businesses make strategic sense? What can those businesses do together that neither could accomplish separately? Which company should be the buyer, and which the seller? Exactly what does each party bring to the table, and how much are those capabilities really worth? What is a reasonable closing price, and how will post-transaction risk be distributed among buyer and seller? How should the deal be financed, and what are the tax, financial, and legal ramifications of the various options? What sort of investigation should we make of each other? How can we encourage a full alignment of interests among all constituents in the go-forward company? What should the obligations of the parties be under the acquisition agreement? How do we avoid the winner’s curse and seller’s remorse? And all along the process, let us be asking how (if at all) we will integrate the resources, processes, and responsibilities of the companies being combined—while bearing in mind the option of divestiture.

The next eight chapters will explore each of these phases in detail, before covering public companies, distressed transactions, and the global scene. Landmark legal cases will conclude our book.

GOAL

The objective of this book is to acquaint the specialist and the nonspecialist alike with the basics of the friendly negotiated acquisition, including the financial, legal, accounting, and business practices and rules that govern deals done today. It is also intended to give the reader some feel for the way that today’s deals are being negotiated.

As mentioned earlier, the chapters of this book follow the basic sequence of the acquisition process, from strategy and valuation to financing, structuring, investigating, and negotiating deals—right up to, and including, closing and postmerger integration. Much of the content of these chapters is advanced and sophisticated; it would not be particularly useful if it were not. Yet the hope is to explain such material as plainly as possible. Each chapter starts with the relevant fundamentals of each topic. Through the Socratic question and answer process, each point builds organically on the one preceding it—a dialogue, if you will, that leads a novice to the point of asking advanced questions, while still serving as a technical reference to the sophisticated dealmaker. It is an ambitious goal, to be sure, but one which we are hopeful that this book has refined over the past 30 years.

For example, since the subtitle of this book is A Merger, Acquisition, and Buyout Guide, it makes sense to differentiate among these key terms. Let’s begin by exploring each of them.

KEY TERMS

What’s the difference between a merger and an acquisition?

The answer to this question is not as simple as it may seem. The term merger suggests two companies of similar size and market value coming together, whereas the word acquisition implies a large company purchasing a smaller business. Colloquially, these descriptions do reflect conventional, everyday use in most circumstances—at least as such terms might be used in the business media such as CNBC or The Wall Street Journal. For instance, it would not be surprising to witness two equally sized businesses announcing their consolidation to the public as a merger of equals.⁵

But merger talk is really more about public posturing and boardroom politics than it is about the legal structure of the transaction. Indeed, the terms merger and acquisition really have nothing to do with the relative sizes of the constituent companies; a large company by all means can merge with a small company, just as a purchasing company can acquire a like-sized target. Rather, the terms merger and acquisition actually allude to the legal structure of a particular deal. Acquisition is the generic term used to describe a transfer of ownership. Merger is a narrow, technical term for a particular legal procedure that may or may not follow an acquisition. Chapter 5, Structuring Transactions, explains how that works.

What then, exactly, is an acquisition?

A corporate acquisition is the process by which the stock or assets of a corporation come to be owned by a buyer. The transaction may take the form of a purchase of stock or a purchase of assets. In this book, we often refer to the acquired corporation as the company or the target.

And what is the technical definition of a merger?

The word merger has a strictly legal meaning and has nothing to do with how the combined companies are to be operated in the future, or which side’s management team is ultimately in control of the post-transaction business.

Simply stated, a merger occurs when one corporation is combined with and disappears into another corporation. For instance, the Missouri Corporation, just like the river, merges and disappears legally into the Mississippi Corporation. Missouri Corporation stock certificates are surrendered and exchanged for Mississippi stock certificates. Missouri Corporation has ceased to exist. Missouri is the nonsurvivor, while Mississippi Corporation is the survivor.

All mergers are statutory mergers, since all mergers occur as specific formal transactions in accordance with the laws, or statutes, of the states where they are incorporated. However, there are rarely major differences between states. (Outside the United States, of course, there are differences from country to country.)

The postdeal manner of operating or controlling a company has no bearing on whether a merger has occurred. It is misleading for a prospective acquirer to state to a prospective seller, We don’t do acquisitions; we only do mergers, implying that the two groups will be equal partners in enterprise, when in fact, and by statute law, one corporation is owned and, without an agreement by the stockholders to the contrary, is controlled by another.

In a merger, who gets to be the survivor? Is it always the larger company?

Not necessarily. For tax and other reasons, sometimes big Mississippi Corporation might be merged into little Missouri Corporation, with Missouri the survivor. Size of operations, net worth, number of employees, who winds up as chairperson, even the name selected, have nothing to do with which company is the corporate survivor.

What is a buyout—and in particular, what is a leveraged buyout?

The term buyout is used to describe a transaction in which an acquirer such as a private equity firm takes all or part of a public company private by purchasing all of its equity and/or assets.

The most common form of buyout is a leveraged buyout (LBO), in which all or part of a company’s capital stock or its assets are purchased with borrowed money, with the assets of the target serving as the primary collateral for the loan, resulting in an above-average percentage of the company’s new capital structure to be in the form of this acquisition debt. The cash flows of the acquired business are then harvested over time and used to repay this debt.

For many readers who are new to LBOs, the most tangible analogy might be the process of purchasing a house. Many homeowners might put, say, 20 percent of the purchase price down in the form of equity toward the acquisition of the house and borrow the remaining 80 percent from a bank, using the house as collateral for the home. To more closely tailor this home-buying example to an LBO, we might further assume that the house will be a rental property investment of the buyer. Accordingly, the buyer will use the rental income from the investment property to subsequently pay down a portion of the acquisition debt. Over time, and assuming the investment is successful, the amount of debt decreases and the value of the buyer’s equity interest in the property increases. In the same way, the buyer-borrower in a leveraged buyout hopes that future income will more than offset the debt payments that must be made.

There are several types of leveraged buyouts, including:

   Management buyouts (MBOs), in which a key ingredient is bringing in the existing management team as shareholders

   Employee buyouts (EBOs), in which the employees, using funds from an employee stock ownership plan (ESOP), most of which will have been borrowed, buy out the company’s owners

   Restructurings, in which a major part of the acquired assets is subsequently sold off to retire the debt that financed the transaction

What is a hostile acquisition or takeover?

A hostile acquisition or takeover is one in which the would-be buyer bypasses the board and management and directs its overtures directly to the target’s shareholders. These types of transactions are rare; the vast majority of acquisitions are friendly or negotiated transactions—largely because it can be unusually difficult to force someone to sell his or her business if the owners are unwilling to entertain negotiations. Nevertheless, hostile acquisitions can, and do, occur when the target is publicly traded, because although the public company’s board and management might be unwilling to engage with a potential buyer, that buyer has the option of bidding for the target’s shares directly from the investing public. This book addresses some issues relating to hostile takeovers in Chapter 10, on public company acquisitions. In general, however, this book focuses on friendly transactions—negotiated deals struck voluntarily by both buyers and sellers. They are based on mutual accommodation of the interests of two or more parties that believe they will be better off together than apart if they can just work things out through the deal process.

ABOUT OUR QUESTION-AND-ANSWER FORMAT

All along the M&A journey questions arise. This book attempts to anticipate them on your behalf, no matter where you are in the process. If you are involved in a transaction, you will find yourself using this book’s extensive index to find answers to your specific, timely questions. If you have a term for a specific point—if you want to know about fraudulent conveyance or the Herfindahl-Hirschman Index, for example—look it up directly in the index. If the point has a number but not a name—for example, Section 338 or Rule 10b-5—look it up under Section or Rule in the index. If you want to review a broad area of the acquisition process—for example, financing—look that up in the index and there you will find the book’s entire coverage of that area, organized alphabetically by each aspect of financing that appears in the book. Run your eye down the headings until you see where to start reading.

Throughout the book, where legal cases contribute important precedent, we have provided brief descriptions in the text. The most important cases in the merger/acquisition/buyout area are fully described in the landmark case summaries, also found in Landmark and Recent M&A Legal Cases, at the end of this book.

CONCLUDING COMMENTS

We cannot claim comprehensiveness in all areas. After all, there are not that many universalities or even commonalities to the merger process—especially those that involve the growing and constantly changing field of transnational agreements and financings.

What we have delivered, however, is a sourcebook in readable form where the entrepreneur and the professional alike can find not only the answers to a myriad of M&A-related questions, but also the questions that must (or at least should) be asked about the M&A process. Such thirsting for knowledge is good.

Drink deep!

NOTES

1.   See https://www.sourcemedia.com/about.

2.   Stanley Foster Reed, Dedicated to the Ever-Renewing Corporate Society, Mergers & Acquisitions, vol. 1, no. 1 (Fall 1965).

3.   $1 from January 1985 was worth $2.30 in January 2017. See https://www.bls.gov/data/inflation_calculator.htm.

4.   Robert F. Bruner, Deals from Hell: M&A Lessons That Rise Above the Ashes (New York: John Wiley & Sons, 2005). Dean Bruner cites the merger of AOL and Time Warner, which led to $100 billion in losses reported in 2003, and the acquisition program of Tyco International, among other bad deals.

5.   Harris Corporation and L3 Technologies to Combine in Merger of Equals, press release, November 5, 2018, https://www.marketwatch.com/press-release/united-states-harris-corporation-and-l3-technologies-to-combine-in-merger-of-equals-2018-11-05.

CHAPTER 2

Strategy

INTRODUCTION

This chapter addresses the first stage in the merger/acquisition/buyout process: strategy.¹ In this crucial phase, company leaders chart the future of the business with a plan that may include a future merger, acquisition, or divestiture.²

When thinking about M&A strategy and the rationale behind a particular transaction, it is helpful as a starting point to consider whether the buyer is a strategic acquirer or a financial acquirer—particularly as the two types of acquirers will typically have different motivations and objectives when evaluating an opportunity.

A strategic acquirer, sometimes referred to as a corporate buyer,³ is generally an operating company with at least one, and perhaps several, business lines that is considering whether to transact with another operating company to either grow or more narrowly focus the acquirer’s business. There are many reasons why a strategic buyer might pursue acquisition efforts; such objectives might include strengthening the acquirer’s existing enterprise by purchasing one or more companies to build a portfolio of business lines; reducing costs, perhaps by spreading fixed costs over a larger number of sales units; increasing market share and therefore pricing power; and/or enhancing long-term value by securing one or more strategic options for the future. The pages that follow in this chapter are focused primarily on the needs and alternatives of strategic buyers, and these four main M&A strategies will be detailed in the first section of this chapter.

The other kind of buyer is known as a financial acquirer—usually an investor group such as a private equity fund making an investment in a company with the specific intent of reselling later at a profit. Such a purchaser will focus principally on whether the company will either generate enough cash flow to handle the debt service requirements of the transaction or perhaps have sufficient severable assets that can be sold off piecemeal, while still representing an attractive whole-company sale candidate looking ahead three to seven years. Indeed, the eventual divestiture of the target—whether in part or in whole—is an integral part of a financial buyer’s plans from the outset, whereas most strategic buyers evaluate deals from the perspective of potentially managing the asset forever.⁴

One might say, then, that a financial buyer is an opportunity taker, whereas a strategic buyer is an opportunity maker. Although this chapter emphasizes the motivations of strategic acquirers over financial acquirers, it is worth noting that financial buyers have never been a bigger part of the corporate M&A market than they are today.⁵ Moreover, financial acquirers can benefit from studying this chapter as well—for instance, if the financial buyer is embarking on a consolidation play or a roll-up in which the financial sponsor intends to make multiple acquisitions in a particular market segment with the intent of wringing out cost savings—although not all sections will apply.

The corporate acquirer reading this chapter will receive guidance for M&A strategic planning—be it to diversify, save, grow, or hedge. Nevertheless, this planning is only the beginning because any decision to acquire means finding a willing seller, and any decision to sell means finding a willing buyer. Thus, strategy naturally influences the search process—that is, the would-be buyer’s acquisition criteria and means for screening the market, as described in the second section of this chapter—whether that process is managed internally or with help from business brokers in the small and midsized market⁶ or, at the higher end of the market, investment bankers. Finally, all strategic planning requires attention to legal and regulatory constraints. The third and final section of this chapter will address those necessary limits.

With this introduction in mind, then, let us now begin at the beginning, by getting acquainted with that somewhat mysterious activity known as strategy—or, more dynamically, strategic planning.

STRATEGIC PLANNING

What is strategic planning?

Perhaps you have heard the old saw Failing to plan is planning to fail. Goals—whether personal or corporate—do not magically arrive on one’s doorstep like a parcel delivered from Amazon. Strategic planning involves thinking ahead about the specific, desired outcomes one wishes to accomplish and how best to achieve those goals. To say that a plan is strategic means that the plan is linked to a targeted outcome that is simultaneously broad, long term, and core to the central mission of the organization. Strategic plans are the kind set by leaders. (In fact, the Greek root, strategein, means the general of an army.)

A strategic plan for a company—sometimes referred to as a corporate strategy or enterprise strategy—will typically be led by individuals with a high degree of responsibility for the enterprise’s overall strategy—the board and senior management—and then used as a road map to guide the direction of countless individual decisions by the broader organization.

Most strategic plans (again harkening to the word’s root meaning) are based on the idea of competition, showing awareness of an opposing force such as a competitor who wants the same thing the planner does—for example, more customers. A thoughtful and effective strategic plan may chart a path for upending a rival firm, whether by lowering production costs, developing a better product or service, or delivering the product or service in a competitively superior way. These are the three generic strategies identified by Michael Porter of Harvard University in his classic book Competitive Strategy.⁷

For the outline of a strategic plan, see Exhibit 2-1.

Exhibit 2-1   Outline for a Typical Strategic Plan

What are some typical strategic planning approaches?

For many years, under the banner of diversification, strategic planning systems abounded. Some prepackaged solutions segmented a company’s operations into market-share/market-growth categories and yielded such classifications as star for high-growth/high-share, dog for low-growth/low-share, cash cow for high-share/low-growth, and wildcat (or question mark) for low-share/high growth. The basic point of this strategy—originally developed and successfully promulgated worldwide by the Boston Consulting Group (BCG) more than half a century ago—was to redeploy revenues from cash cows to wildcats. Many other such matrix approaches to diversification were also popular, especially General Electric’s nine-element construct. Such concepts have been widely taught and used. Why? Because they were certainly better than the random processes that had gone on in previous decades, during which many deals were made for noneconomic reasons—fads, friendship, or family ties.

But now, in the age of big data, these simple four-element and nine-element matrixes have been supplanted by multivariate analyses. Rather than four or nine, there are literally hundreds of variables that may be considered when contemplating a growth-by-acquisition strategy. These more systematic approaches to planning will isolate the key variables, and use those variables to develop strategic plans that will work.

In addition, some companies have begun supplementing their systematic approaches with adaptive adjustments to respond to changes in the environment.⁸

How does strategy relate to vision and mission?

Building a successful business is like constructing a stable building. Start with a firm foundation and work your way upward. Before pursuing any strategy, decision makers should recognize an organization’s mission (why it exists) and vision (what it is striving to become). Strategy is the path to fulfill the mission and reach a vision. Merger, acquisition, and/or divestiture plans are vehicles for moving down the path.

THE ROLE OF M&A IN STRATEGIC PLANNING

How does M&A fit into strategic planning?

First and foremost, M&A is a decision that occurs along a path of decisions. A typical decision tree would proceed as shown in Exhibit 2-2.

Exhibit 2-2   M&A in a Strategic Decision Tree

Source: Alexandra Reed Lajoux, 2019.

Can M&A be called a kind of strategy?

No. M&A is not a corporate strategy in and of itself, although such transactions can play a pivotal role in implementing a strategic plan. As Porter notes, [A] merger can instantaneously propel a weak competitor into prominence or strengthen an already formidable one.⁹

Before deciding to enter a new area of business, strategic thinkers will make industry forecasts and study the fit of the proposed acquisition with their present operations. Furthermore, because strategic planning requires choices, any opportunity, no matter how hot, should always be forced to stand trial against other potential entries. This means taking a formal inventory of opportunities and then methodically comparing them.

The plan resulting from strategic thinking, once installed, acts as a disciplining force on everyone at the decision-making level. Any proposed transaction can simply be matched against pre-agreed-upon criteria that describe the company’s strategy. If the proposed transaction doesn’t meet most of these strategic criteria, the opportunity is rejected, saving executive time and resources.

Strategic planning can also help in the divestiture process. In any multi-profit-center operation, strategic planning that does not automatically produce candidates for sell-off or shutoff is probably not truly strategic. It is necessary in any strategy to weigh what a business is doing against what the business could be doing with its resources. If the potential is greater in new areas of opportunity, the old lines of business should be converted to cash by selling them off, possibly at a premium to a firm where they fit, and the cash should be redeployed to new lines through internal or external development. Controlling this continuous redeployment process is an important aspect of strategic planning.¹⁰

The best M&A strategies are based on an analysis of an organization’s strengths and weaknesses, as well as its opportunities and threats—a SWOT model that holds true today, after half a century.¹¹

Overall, why does M&A activity rise and fall? For example, what is driving the current M&A resurgence?

An FTC panel report (based on a focus group with 10 executives) once counted 31 motives, ranging from expanding product lines to increasing managerial strength.¹² At the other extreme, legendary investor Warren Buffett has philosophized that there is only one reason for M&A activity: to move investment out of cash and into assets. For many companies, there are usually a variety of motives. Scholars generally agree on the following 10 most common reasons why companies make acquisitions:¹³

   Achieve economies of scale by buying a customer, supplier, or competitor (operating synergy)

   Accomplish strategic goals more quickly and more successfully (strategic planning)

   Realize a return on investment by buying a company with less efficient managers and making them more efficient (differential efficiency)

   Realize a return by buying a company with inefficient managers and replacing them (inefficient management)

   Increase market share (market power)

   Lower cost of capital by smoothing cash flow and increasing debt capacity (financial synergy)

   Take advantage of a price that is low in comparison to past stock prices and/or estimated future prices, or in relation to the cost the buyer would incur if it built the company from scratch (undervaluation)¹⁴

   Assert control at the board of directors level in an underperforming company with dispersed ownership (agency problems)

   Obtain a more favorable tax status (tax efficiency)¹⁵

   Increase the revenues or size of a company and therefore increase the pay and/or power of managers (managerialism—never a stated goal, but an explanation offered in many academic studies)

ALTERNATIVES TO M&A

Is M&A the primary type of corporate transaction that businesses use to fulfill strategy, mission, and vision?

Not necessarily. When two organizations wish to collaborate in some way to accomplish similar objectives, there is a wide range of corporate transaction structures that management might consider—M&A is just one option. The precise structure that might work best in any given situation may depend on a wide variety of factors. The initial question to ask oneself is whether some degree of shared ownership between the respective parties is necessary to accomplish the intended goals or whether the parties might be able to achieve those goals though contractual or even less formal relationship. Among the factors to consider include the following: How much influence does one party want over the other’s corporate decision making, and how receptive is the other side to that request? How much capital does each party have, does each party need, and is each party willing to commit to maximize the results of the collaboration? How closely integrated should the collaboration be, and must that integration be permanent?

Exhibit 2-3 illustrates a range of structures for business collaboration.

Exhibit 2-3   Range of Structures for Business Collaboration

Source: Silver Lane Advisors, 2018.

As illustrated in Exhibit 2-3, these structures might be as informal as a trading relationship, in which the buyer and seller periodically enter into one-off purchase-and-sale transactions of goods or services. In some circumstances, the parties might be capable of achieving their strategic objectives merely through a contractual relationship. Examples include a supply agreement that outlines the basis upon which the buyer and seller will operate over time; a floorplan agreement, which is common between original equipment manufacturers (OEMs) and distributors to provide short-term inventory financing from the OEM to the distributor to take inventory and offer it for resale (e.g., GM and its auto dealership partner); or some form of licensing agreement, which dictates precisely how the licensee can and cannot use the rights granted by the licensor. Alternatively, the contemplated business collaboration might be optimized if the parties were to somehow integrate equity ownership into the structure—whether in the form of a passive minority stake, a minority stake with a formal operating alliance, or a joint venture of some kind. A full-out merger or acquisition involving the constituent companies might be thought of as the most extreme form of business collaboration—reserved for scenarios in which the buyer seeks a high degree of influence over the other party and is prepared to commit meaningful capital to the operation. A merger or acquisition is also a logical transaction structure in the event the acquirer wants to fully integrate the target into the acquirer’s business. However, integration is not a requirement of M&A. There are plenty of examples in which an acquirer wished to operate the target as a stand-alone but, for strategic reasons, wanted to own 100 percent of its equity.

Research shows that a significant percentage of acquisitions fail in some way. Are they worth the risk?

This is a question of facts and circumstances. Sometimes an acquisition is the right strategic choice, and other times this would be the wrong move. Chapter 9 of this book, on postmerger integration, discusses postmerger returns, based on the latest research.

To begin with, let’s consider the clearly positive case of one small company buying another in an emerging industry. Few would criticize Coinbase’s decision to take over other start-ups in its fields through a series of acqhires, buying companies to engage the talents of their founders. This is a new twist on the roll-up strategy mentioned earlier.¹⁶

This said, it is notable that acquisitions are particularly risky for small-cap firms in public markets because of the chain of events that may occur if shareholders do not agree with the deal. Whereas companies with a vast number of holders can weather a shareholder revolt, a small-cap company cannot.¹⁷

   First, if investors sell the company’s stock, short it, or simply don’t trade it at all, stock price and/or volume might suffer, making any attempts to access the equity capital markets more dilutive. In the worst-case scenario, it could all but foreclose access to the equity markets.

   Second, if trading volume dries up, the company also won’t be able to use its stock as acquisition currency; that is, high-quality companies won’t want illiquid stock as purchase consideration.

   Third, high-quality, sell-side research firms have seen the same small-cap M&A movies that fund managers have, so the chance of getting impactful research is going to be diminished.

   And, fourth, but certainly not least important, many small-cap officers and directors—in my experience—underestimate how much a pressured/languishing stock can impact employee recruitment, retention, and morale.

Do you mean to say that small-cap, buy-side folks are intuitively against all acquisitions? Even one-offs?

The short answer is that organic growth is nearly always going to be valued more highly than corporate acquisitions in the small-cap realm. That said, there is a flavor of small-cap M&A that can be quite successful: tuck-in technology/IP asset purchases—an art perfected by Cisco. In other words, unique situations, where it’s faster, easier, and cheaper to buy technology, intellectual property, or physical property rights from a third party, can be quite accretive. The reason they can work well is that you’re buying a widget, and perhaps a small team of technical people, and that’s it. You’re not acquiring liabilities, business models, corporate cultures, and the rest.

SWOT ANALYSIS

What exactly is SWOT analysis and how is it used in the strategic planning process?

SWOT analysis is a useful framework often used at the kickoff of a strategy formulation that is intended to help management develop a sustainable niche in the company’s target market. Some people attribute the original development of the tool to Albert S. Humphrey, a management consultant for the Stanford Research Institute (now known as SRI International) in the 1960s, although that attribution has been debated over the years. Ultimately, SWOT analysis is intended to identify the internal and external factors that either support or hinder an organization’s ability to achieve its stated mission. Factors that are internal to the organization are its strengths and weaknesses, while factors that are external are the opportunities and threats presented by the outside operating environment. Exhibit 2-4 summarizes sample questions that can help to guide an organization’s SWOT analysis.

Exhibit 2-4   Sample SWOT Analysis Questions

Source: https://www.mindtools.com/pages/article/newTMC_05.htm.

The SWOT approach implies that the ideal M&A process will target industries and companies where an acquisition will both exploit strengths and shore up weaknesses. In the process, the M&A staff truly becomes an opportunity maker, pursing only those opportunities that will fit with its chosen strategy. The original senior author of this work, Stanley Foster Reed, developed a proprietary methodology for determining strategic direction and target fit called the Wheel of Opportunity and Fit Chart (WOFC) approach, which allows decision makers to generate and prioritize target criteria. Planning of this sort greatly reduces the cost of analyzing randomly submitted opportunities. Do they fit at all? If so, how well do they fit? A truly sophisticated strategic plan