Mergers Acquisitions & Divestitures (M&A) Cycle

There are a myriad of reasons businesses sell:  

• No succession plan when you retire
• Children not interested in continuing the business
• All your equity (and therefore retirement assets) is tied up in the business
• You are sub-scale in a business where size matters

But, before you engage the bankers or raise the "for sale" signs, pre-sale preparation can increase your return substantially.  

Key issues here can include

• Managing/Improving results ahead of time to attract a higher sell price
• Identifying and perhaps removing costs of a personal nature
• Understanding and optimizing working capital true-ups prior to setting targets in an agreement
• Knowing and preemptively fixing any legal, tax, benefits, and other compliance gaps
• Strategic and legacy decisions about who to sell to:  strategic buyers, competitors, private equity, or employees (ESOP)

Most times companies aren't looking to acquire only for growth's sake.  There is a geographic growth need, a need for scale economics, to fill out network density, or a product extension or compliment.  The M&A choice fits into a strategic plan.  So identifying targets to acquire should take those strategic imperatives into account.  

Also relevant is the size of the target pool.  Where lots of alternatives exist, you can proceed differently than if there is a small number of ideal acquisition targets.  

Key questions can include

• Alignment of client bases
• Alignment of channels to market 
• Product / Service synergies
• Technology compatibility or synergy 
• Client "stickiness" of target's products/ services
• Dependence on target's leadership, key players, or service workforce
• Cultural compatibility

The financial model, or pro-forma, is where financial history, future projections, and deal rationale all come together in numerical and financial expression.  

You need to know how the existing and acquired business can or should perform, separately and combined, and the synergy represented in the combination is an important determinant in how much you're willing to pay to acquire the firm.  The pro-forma model is also a critical input to the various sources for funding the deal.

Key elements and issues:  

• Historical financials for both firms
• Forecasts for both firms on a stand alone basis
• Detailed synergy assumptions - revenue, margin, and SG&A 
• Alternative Scenarios for forecast and synergies
• Cost of capital considerations depending on alternative funding scenarios
• Ongoing adjustments to model assumptions through Due Diligence and finalizing the Purchase Agreement

Due Diligence involves getting under the covers of the company being bought/sold so that the buyer gains confidence that they understand what they're buying, "kick the tires" to look for undisclosed problems, and confirms or refutes modeling assumptions.  

The diligence process can be well-organized or haphazard, go smoothly or rocky/stormy, and last a short or longer period of time.  

The list of issues here is large, often organized functionally.  

• Legal validation of ownership and regulatory compliance
• Validating published financials and speaking with external auditors
• Review of granular accounting details
• Tax compliance and synergy assessments
• Degree of access to internal employees
• Client interviews
• IT Security reviews
• Operational audits

The Purchase and Sale Agreement is the focal point of the M&A process.  That document, and often numerous exhibits schedules and related documents, codifies the details and terms of the purchase, lays out pre-conditions and representations and warranties, as well as ongoing post purchase obligations for the parties.  

The process of codifying the agreements can often cause breakdowns because of mis-understandings about "the deal" or purchase price, and is also affected by Due Diligence findings.  

Key Features and Issues

• Pre-conditions to sale
• Retention and non-compete agreements for key personnel
• Related agreements for facilities, intellectual property, ongoing support services, etc. 
• Post-sale obligations
• Attention to detail:  full understanding of "the deal" without post-sale surprises

Most times a purchase will be funded by a mix of external debt and buyer-supplied equity.  But there are many variations to that simple theme, including seller financing and post-acquisition earn-outs.  

The more complex the funding structures, and the more players involved, the more effort this stage takes.  

Key Features here are

• Securing debt from banks or other lenders
• Equity raise from existing owners, new investors, private equity, etc. 
• Ongoing seller stakes including seller notes and performance-driven earn outs
• Tax and other government incentives that may need to be finalized at closing

Closing an acquisition brings post-sale administration to do's, which can be laborious and affect deal economics if not done fully and correctly.  These include obligations by sellers and buyers, and to sellers, buyers, banks, equity investors, landlords, suppliers, clients, regulators, and state local and federal governments.    

Examples include

• Legal entity filings in organizing states 
• Tax filings in states and municipalities
• Duty to inform and/or contract assignments with clients
• Duty to inform and/or contract assignments with suppliers 
• Landlord notifications for leased space 
• Notification and contract assignment to lenders not party to the purchase/sale (e.g. equipment lessors) 
• Debt provider security interests 
• Debt provider ongoing reporting 
• Tax Credit or Government incentive filings (initial, ongoing)

The process of actually combining two companies can be the longest and most resource intensive part of the M&A cycle.  It also can "make or break" the success of the deal.  

When done well, acquisition integration helps the company meet or exceed its growth, profitability, and market objectives.  Conversely, a poor integration can result in lost synergies, declining performance, and ultimately an unsuccessful acquisition.    

Like other areas of M&A, Integration is a "whole team" effort, best organized functionally

• Post-Close Audit
• Asset Valuations
• Opening Balance Sheet
• 30/90/180 Day Checklists, by function
• Communication Plans
• Organization structure and retention decisions and actions
• Roadmaps for growth, profitability, and synergy achievement, with milestones and KPIs

We outline a special M&A cycle element for situations when only parts of a business is being bought/sold, often referred to as a Carve Out.  These situations bring their own concerns, mostly involving separating products and services, locations, teams, and processes that were previously combined with others inside the selling business.  They create special issues because the seller often wants the carved out business out of its hair before the buyer is fully prepared to absorb the carved out business.  

Key Features here are

• Ongoing support agreements with performance or service level commitments
• Making carved out employees feel welcome and engaged
• Creating stand alone processes, systems, or teams, where previously they were but a piece of something bigger.