Practitioner's Complete Guide to M&As: An All-Inclusive Reference

By David T. Emott

The ultimate guide to the ins and out of mergers and acquisitions

Practitioner's Complete Guide to M&As provides the practical tricks of the trade on M&As: what they need to know, what they have to know, and what they need to do. Numerous examples and forms are included illustrating concepts in discussion.

• Written in a straight-talking style
• A highly, practical application-oriented guide to mergers and acquisitions
• Covers strategy development; deal flow and target identification; due diligence; valuation and offers; tax structuring; negotiation; and integration and value creation"
• Presents information using bullet points rather than lengthy narrative for ease of reading
• Numerous exhibits, forms, and examples are included

This practical guide takes you through every step of the M&A process, providing all the necessary tools that both the first-time M&A player as well as the seasoned practitioner need to complete a smart transaction.

• Language: English
• Publisher: Wiley
• Release date: Apr 6, 2011
• ISBN: 9781118015919

Book preview

Topic 2

M&A Process: Front to Back

This topic and Appendix 2.1 present an overview of the M&A process activity and stages typical of most corporate development processes. Auction M&A transactions, which share most of the activities presented but on a more compressed timeline, are covered in Topic 12.

APPENDIX 2.1 M&A Process Activity and Stages Map (Topic Reference)

ch02fig001.eps

The reader is encouraged to take the time to read through the sequential time line of activities on Appendix 2.1 to gain a feel of the flow of events. Topic numbers are listed in parentheses next to each activity that is expanded on in the text that follows.

DEFINITION OF THE M&A PROCESS

Preparation. Deal flow starts with strategy development and development of target acquisition criteria (see Topic 4) and runs through creation of deal flow.

Acquisition criteria are developed in a collaborative process that attempts to capture the qualitative and quantitative attributes of attractive target markets and target companies. They are used as a screen to rule target candidates out or in.

Deal flow can emanate from internal sources, including research and development, sales and marketing, corporate development efforts, and programs such as activity extension and brainstorming and external efforts, such as mandated investment banks, targeted searches, over-the-transom offerings, or competition.

Activity and Contact. This activity starts with market and target evaluation including preliminary intelligence gathering, criteria screening, and a target prospect report.

If not rejected at this stage, contact with the target and potential establishment of common, complementary interest between buyer and seller follows.

Come to Terms. This stage encompasses expanded preliminary due diligence, deal valuation and offer structuring, deal financing and value creation, synergies realization, and integration plan development. A preliminary letter of intent (LOI), offer term sheet, and acquisition proposal are presented internally for go-forward approval and degrees of negotiation freedom.

If not rejected at this stage, target contact, negotiation of deal elements, and a conditional offer ensue.

Close It. This phase encompasses expanded final due diligence, final deal valuation and offer structuring, deal financing and a value creation, synergies realization, and integration plan. A final offer term sheet (LOI) and acquisition proposal are presented internally for go-forward approval and degrees of negotiation freedom.

If not rejected at this stage, target contact, final LOI is agreed and negotiation of deal and principal contract terms ensues.

Create Value. This stage includes the execution of integration plans and realization and measurement of deal synergy and market, product, and customer, objectives.

Appendix 2.2 illustrates the typical level of involvement of various business functions pertinent to the each stage of the process on the Matrix of Responsibility and Authority in M&A Transaction Flow.

APPENDIX 2.2 Matrix of Responsibility and Authority in M&A Transaction Flow

ch02fig002.eps

Topic 3

Why M&A?

Topic 3 summarizes the rationale for undertaking M&A. Acquirers should have specific reasons that target their M&A effort to fill a strategic void (see Topic 1). M&A is not without risk. Having operational overlaps with potential targets is a reasoned way to mitigate potential risk impacts. Additionally, acquisition risk is mitigated by building your M&A capabilities with smaller, digestible deals before taking on a large one.

DEFINE THE ROLE AND GOAL FOR M&A

Based on your strategic planning process, know the role you want an acquisition to play (see Topics 1 and 2).

What do you want out of M&A? Consider these choices:

Improve market or channel access position

Improve product line or served market extension

Fill a technology or other operational capability gap

Achieve a targeted competitive advantage

Promote growth or geographic expansion

Eliminate redundant costs (plants and overhead consolidation)

Consolidate or exploit excess capacity

Improve long-term return on investment (ROI)

Do a roll-up or consolidation leading to an initial public offering (IPO) or strategic sale

Achieve incremental size and volume

Do it just for the adventure (not a good idea)

Deals are not about taking risk; they are about taking on and managing risk to achieve a desired end.

The closer the capabilities and activities of the target company are to what the buyer knows and does well, the better the buyer can manage the risk of what can (and generally does) go wrong. (See Topics 26 and 27.)

Having said that, many buyers enter into deals to fill certain buyer capability gaps with those possessed by the target.

LOOK FOR CAPABILITY OVERLAPS WITH TARGETS TO BALANCE ACQUISITION RISK

Strategic buyers should look for three or four overlaps between their own key characteristics and capabilities and those of the acquisition target to increase the likelihood of a successful acquisition and integration. Important overlaps can include:

Served customer base

Distribution channel and selling process

Marketing and product positioning process

Technology base employed and technology development process

R&D project management process

New product development and deployment process

Lean manufacturing method and process expertise

Procurement process, vendor base, and vendor development process

Management processes and practices

Company culture

Deals motivated to fill certain buyer capability gaps with those possessed by the target, which is often the case in strategic deals, are not unusual. In such deals, the buyer should have some overlap knowledge of the acquired capabilities. Elimination or enhancement of certain redundant capability overlaps and overhead expense is also often a motivator.

The likelihood of post-closing deal success declines quickly where buyer knowledge of acquired capabilities is very limited, unless a highly effective integration planning process that executes well mitigates the lack of capability overlap.

Things that can go wrong generally do; acquirers must remedy the problems quickly and a lack of acquired capability knowledge can be a problem if, for example, the acquired capabilities are found to be deficient or a key acquired employee leaves. (See Topics 51 and 52.) Buyers must be able to fix things that go wrong.

The buyer must balance risk mitigation of overlaps with the need to expand the capability base.

New entrants to M&A activity should start with smaller deals and build a set of acquisition and integration capabilities before tackling larger, more complex transactions.

Topic 4

Deal Criteria

Topic 4 discusses in depth the need for well-thought-out criteria to guide the acquisition search and candidate evaluation. Acquisition criteria capture the essence of what the acquirer is after and provide a basis for measuring both how close a target is to the ideal fit and helps identify the target's strengths and weaknesses. Criteria development allows the chief executive officer (CEO) and board of directors to emphasize what matters most to them. It must be emphasized during acquisition search and evaluation. This topic illustrates acquisition criteria and criteria rating.

DEAL CRITERIA DEVELOPMENT

Having clear acquisition criteria helps narrow your search, develop the search mandate, and eventually make choices between candidates. Illustration 4.1 provides an example of acquisition criteria.¹ Readers should consider all and select those most relevant to their merger and acquisition goals.

ILLUSTRATION 4.1 POSSIBLE ACQUISITION CRITERIA

Strategy Output Criteria for Target Identification (see Topic 1)

Industry/business/product/service area sought to close identified gaps

Technology/know-how/enabling competency sought to close identified gaps

Geographic dispersion sought to close identified gaps

Qualitative Criteria for Target Consideration and Evaluation

Have a clearly stated description of the characteristics of the industry, technology, market segment, and product or service line sought, and include it in your criteria.

Ensure that the criteria against which target candidates are measured also reflects the critical capability overlaps desired (see Topic 3).

Acquisition candidates should compare favorably in their current state with most of the general, qualitative, and quantitative criteria or have the potential to get there under new owners.

Develop criteria for a potential buyer that reflect the specific factors that result from its strategy development and strategic gap identification process (see Topic 1).

Identify critical knock-out criteria that must be met by a potential target as it is or shortly after a change in ownership.

Ensure that criteria developed for a given target also provide the framework to focus the due diligence process work (see Topic 10).

Develop a quantitative rating for each potential candidate against the general and specific criteria to assist in completing the relative target attractiveness evaluation. Does the target meet the criteria or not? If not, where does it fall short? This observation can help you evaluate why and whether the target has the potential to meet the criteria post acquisition. A criteria rating approach is presented next.

CRITERIA RATING ENGINE

Appendix 4.1 presents an example of a criteria rating engine. Follow the numbered elements discussed next and in Appendix 4.1.

Weight the criteria as to the relative importance of each to achieving strategic goals: what really matters to sustaining value growth in the judgment of the CEO and the board of directors (column 1). In Appendix 4.1 the weights range from 1 (least important) to 5 (most important).

Minimum required rating (column 2) is based on the relative weight (column 1) times the desired overall minimum fit target (85% in column 8 of Appendix 4.1) as determined by the CEO and/or the board.

Target criteria score (column 3) should be scored based on the ratings provided by the due diligence process team. Care must be taken to ensure an independent consensus rating based on factual observation and reasoned judgment, given that the desired weighted ratings are known.

The minimum required weighted rating (column 4) is based on the relative weight (column 1) times the minimum required rating (column 2).

The target weighted score (column 5) is based on the relative weight (column 1) times the target rating (column 3). The due diligence process must be focused on obtaining the knowledge required to make reasoned judgments of the target's attributes versus the criteria.

The target score over (under) minimum rating (column 6) is the target's weighted score (column 5) less the minimum required weighted rating (column 4).

The target weighted fit % (column 7) is an indication of how closely the target fits the established weighted criteria. Scores exceeding 100% indicate the target exceeds the criteria; scores less than 100% indicate the target does not meet the criteria. The weighted fit % equals column 5 divided by column 4 for all criteria groups other than the qualitative criteria. For the qualitative group criteria, the weighted fit % is the expected qualitative result (column 3), divided by the target result (column 2), times the CEO's importance factor for each item (column B).

The deviation of the target fit % with the CEO's desired target fit % (85% in column 8 of Appendix 4.1) is shown in column 8 (column 7 less 85%).

APPENDIX 4.1 Criteria Rating Engine

ch04fig001.eps

The target composite weighted fit %—75.2% in the illustration (column 9)—is the sum of the weighted fits for each criteria group subtotal (general, market attractiveness, product and target attractiveness, qualitative) in column 9. The criteria group subtotals equals the sum of the target fit % for each criteria line item in the criteria group (column 7) times the subtotal percentage for each criteria group that each importance weight is to the total of all importance weights (column A).

A secondary criteria rating evaluation should be made if the target composite weighted fit (column 9) falls below the desired fit (column 8) as it is predeal to evaluate whether the target fit is achievable in the hands of the buyer postdeal, after buyer improvements.

The prospective postdeal evaluation will require estimating the impact of buyer initiatives within the target after the closing.

The target composite weighted fit over (under) the minimum fit—9.8% in the illustration—is presented in total in column 10. It is the sum of the weighted over (under) fits for each criteria group subtotal (general, market attractiveness, product and target attractiveness, qualitative) in column 10. The subtotal weighted over (under) fits for each criteria group equals the sum of the target fit % for each criteria line item in the criteria group (column 8) times the subtotal percentage for each criteria group that each importance weight is to the total of all importance weights (column A).

CONCLUSION TO THE CRITERIA RATING ENGINE

The target composite weighted fit over (under) the minimum fit is a measure of how far the target's fit rating is—below the CEO's overall desired fit of 85% (9.8% below in the illustration) against all criteria and which criteria group is lacking most fit. On a weighted basis, the qualitative market attractiveness and quantitative measures exceed the CEO's expectations by 6%, but the general product and target attractiveness ratings are well below the CEO's weighted expectations by 15.8% for a net fit of –9.8% below.

The takeaway may be that the team needs to reassess the attractiveness of the product and the business attributes of the target. While the target scores well on capital intensity, regulatory-driven barriers, and low-cost producer, it does not score well on technology, innovation, and related attributes, which might indicate lower barriers to entry and a weaker franchise position than the CEO hopes for.

WHERE DOES TARGET FALL ON COMPETITIVE CONTINUUM?

It is critical to have a meaningful understanding of the target and its served market in terms of the acquisition criteria. This understanding defines where the company falls on the competitive continuum and therefore how it competes (or should compete) and therefore what its strategic thrusts and initiatives are (or should be) in support of how it should compete.

This understanding allows the buyer to test the consistency of the targets practices and the target's understanding of its position in its market place.

Appendix 4.2 presents an illustration of the potential general end points of the competitive continuum: Proprietary, specialty franchise niche provider'' at one end and Non proprietary OEM provider, distributor'' at the other end recognizing that there are many variations on these themes.

The end points are defined in terms of:

apparent served market attributes,

apparent product and business attributes,

basis of competition characteristics and practices typically associated with the demonstrated attributes,

indicative business strategic thrusts and initiatives associated with the competitive practices, and

the business value proposition that might typically be associated with the continuum end points.

The following Appendix, as well as Appendix 4.1 is available for viewing or download on the Web site for this book at: www.wiley.com/go/emott. Please see the About the Web Site page at the back of this book for login information.

Appendix 4.2 Basis of Competition and Strategic Thrust Is a Function of Served Market, Product, Business Attributes

1. Acquisition criteria are drawn from acquisition criteria development work while the author was employed at The Dexter Corporation in the early 1980s. They remain viable and pertinent.

Topic 5

Deal Sourcing

Deals can be sourced from formal or informal solicitation activity on your part or from unsolicited approaches from a variety of outside sources. Like most things, however, you get what you pay for.

POTENTIAL SOURCES, PROS AND CONS

Potential deal opportunities can arise from targeted corporate development initiatives and mandates, research and development (R&D) efforts, internal skunk works, or unsolicited approaches from:

Employees

Commercial banks

Investment banks

Venture capital firms

Investment management funds

Lawyers

Customers

Accountants

Competitors

Search firms and brokers

Contacts made from attending deal seminars and conferences

Strategy, segment, and target identification work (see Topic 1)

Third-party targeted deal sourcing–related engagement services are provided by investment banks; acquisition intermediaries, search firms and agents and brokers; accounting firms, and others. Services can range from and include:

Assistance in developing acquisition criteria and strategic rationale

Names of sellers or buyers that appear to meet a specific or general criteria

Targeted searches and qualified contacts of sellers or buyers that meet a specific or general criteria

Valuations and/or due diligence

Full-service representation from criteria development, target search and qualification through valuation, conducting an auction, negotiation, and closing

Determine the services you need based on your resources and deal flow interests.

Often, it is less expensive but slower to search out, contact, and cultivate targets on your own.

An opportunistic approach is to provide your deal criteria, including targeted attractive market sectors, to the network of sell-side deal brokers or investment bankers that represent potential sellers to stimulate deal flow within the context of the search mandate. See Appendix 5.1 for an example of a search mandate.

This approach generally produces a wide variety of offerings that may or may not resonate with your search mandate.

A similar approach opportunistic is to attend seminars designed to bring sellers in front of potential buyers. Brief seller presentations to the group are followed by the possibility of one-on-one time with interested listeners.

Local chapters of The Association for Corporate Growth often provide deal exchange seminars (see ACG.org).

A more expensive approach that yields targeted deal flow (not necessarily deals) is to enter into a buy-side assignment with an investment bank or search firm engaged to find potential deals based on your specific search mandate.

APPENDIX 5.1 General Search Mandate

ABC Company seeks to acquire unique manufacturing capability in the fabrication of specialty engineered metal or composite products business serving aerospace and defense, propulsion, automotive racing, earth-moving equipment, and or yacht- and ship-building component or manufacturing industries.

Manufacturer business models should be based on demonstrated high-value customer problem-solving and service relationships resulting in highly engineered solution-oriented products designed to meet demanding, critical-function performance requirements such as:

Airfoil structures

Rigging components

Landing gear or door components

Brake components and materials

Containment and housing structures

Seat components and structures

Aerospace and marine jet engine propulsion components

Steering, power transmission and gearing components

Manufacturer should possess a stable of unique engineering and manufacturing capabilities and activities such as:

Composite resin handling and matrix development

Milling

Forming

Metallurgy

Turning

Casting

Proposal development

Materials research and development and testing

Manufacturer should be recognized as the premier and preferred supplier to a broad base of demanding, high-quality repeat customers in its served client and industry base.

Manufacturer should have:

Sales of $150 to $250 million +

Sales growth of 8% last five years

Sales growth potential of 8% next five years

Ebitda of 10%+; 15–20% potential

RONA of 15%+; 15–20% potential

Topic 6

Fees for Services

Targeted acquisition services by qualified intermediaries will vary depending on the scope of services provided and the reputation and quality of the provider. Topic 6 presents and overview of the nature of the services typically rendered and representative fee structures. It also presents a buy-side fee structure designed to align the interests of the buyer and the buyer's banker.

The reader is encouraged to take the time to read the text in conjunction with the referenced Appendices to gain the appropriate level of understanding of the subject matter discussed in the narrative. Appendices are either presented at the end of this Topic or are available for review and download on the companion Web site noted at the end of this Topic.

OVERVIEW

Fees for service vary greatly, depending on the services and the scope and quality provided.

Project scope and fee basis should be agreed on and documented in an engagement letter between the vendor and the seller or buyer.

Finders retained by sellers (sell-side arrangement) occasionally attempt to collect their fees from buyers:

Buyers who are approached by unsolicited finders should resist accepting a potential target's name and contact until the question of liability for the finder's fee is clarified.

Buyers who are approached should ask unsolicited finders: Who pays your fees?

Buyers should consider taking the position that sellers should pay finder's fees and build such fees into target price expectations.

Buyers should negotiate the purchase price without the encumbrance of finder fee liabilities.

Generally, as a matter of good practice, each party should pay for its own retained experts fees (e.g., finders, legal, advisory, accounting, and tax). Certain fees of benefit to both parties are shared.

Sell-side deal advisory services (and often buy-side arrangements where a banker is retained to sell a property) and fee expectations can be expected to be similar to those in Illustration 6.1, depending on the scope of the effort.

ILLUSTRATION 6.1 OVERVIEW OF SELL-SIDE ADVISORY SERVICES AND BASIS OF FEES

FEE STRUCTURES: AN OVERVIEW

Fee structures vary in complexity, incentive levels, and deal size,¹ as shown in Appendix 6.1.

Lehman scale fees, originally used for initial public offering (IPO) fee determination and sometimes used as a deal fee basis, are expressed as a percent of deal value:

5% of first million of purchase price

4% of next million of purchase price

3% of next million of purchase price

2% of next million of purchase price

1% on remainder of purchase price

Occasionally sell-side deal fees are based on twice the Lehman scale, a stuttering Lehman scale, or a minimum fee plus a sliding scale, depending on the service provider and deal size (see Appendix 6.1).

On very small deals of, say, $5 to $10 million in total transaction value, all-in sell-side full-service representation success fees might range from plus or minus 5% to 8% of the deal value. As illustrated in Appendix 6.1, a deal fee might approximate a minimum of $150,000 plus 4% of the first $5 million, 2% of the next $5 million, and 0.75% of the remainder. For a $10 million deal value, this results in a fee of $450,000, or 4.5% of deal value. A retainer of $50,000 to $75,000 up front (or a monthly arrangement of $5,000 to $15,000) that generally is creditable against the success fee would not be