Anatomy of a Deal: Mergers & Acquisitions

Written by Robert Tyndall:  Managing Director of Investment Banking and Corporate Finance at Fifth Third Bank

U.S. market valuations for middle market companies are at an all-time high according to GF Data, but the cycle may be at a peak.  So for business owners considering a sale of their company or a similar transition in ownership, it is a good time to learn about and evaluate options.  Selling a company is a mission-critical, complicated process often taken on with the help of advisors.  In addition to a market update, this article will describe the process and seller considerations in detail.

I. Sellers M&A Market
II. Sustainability of Strong M&A Market
III. Business Owner Considerations
IV. Process for a Strategic Transaction
V. Timing a Sale Process

2009. Sellers’ M&A Market. The average middle market company today will sell at a significant premium to market values of earlier years. M&A volumes have ranged from $250 to $300 billion per year in the middle market since a low of $140 billion in 2009. M&A activity year-to-date in 2019 is tracking ahead of the same period last year.  Buyers and investors often value companies based on a multiple of earnings before interest, taxes, depreciation, and amortization (EBITDA).  Multiples of EBITDA paid for high quality companies in the middle market are currently very high, making now an attractive time to be a seller in the market.
      Source: GF Data, S&P Capital IQ, Pitchbook, and Preqin
2010. Sustainability of Strong M&A Market. Many of the fundamentals that are driving today’s market should continue to support strong company values, however, there are early indications of a moderating market or eventual downturn.

Sustainable drivers of a sellers’ market include:

1. Record levels of corporate cash and private equity dry powder (about $3 Trillion) indicate that buyers are motivated and have the ability to pay premium values for quality assets Source: Bloomberg S&P CapitalIQ, Pitchbook, and Preqin
2. Readily available and low cost M&A financing from banks and alternative sources, fueled in part by interest rates which are projected to stay low
3. Relatively lower supply of high quality companies for sale driving historically high valuations
4. Stability of banking system, driven by higher standards and regulation, adds certainty to transaction financing and outlook for liquidity

Other market factors with less sustainability or visibility include:

1. Impact of international trade dynamics and policy on U.S. businesses
2. Domestic and international political uncertainty
3. Consumer confidence and employment rates
4. GDP growth and projected company growth
5. Risks of lower regulation and standards in non-bank debt financing sector

It is likely a near-term market downturn would be moderate relative to the severe recession of 2008-2009, due in part to stable liquidity and banking system which was not in place previously.

III. Business owner considerations.  The issues business owners face are multi-faceted and complex, between shareholders, company, management, succession plans, and personal or family issues.  A strategic transaction, such as a sale, may resolve core challenges and meet key goals.

Types of transactions.  There are a variety of common strategic transactions.  An investment banker or other advisor can help a business owner evaluate options and the best transaction for the company.  Often, an investment banker can run multiple transactions in parallel, allowing the company to choose once market feedback is obtained.  Common strategic transactions include:

1. Growth through acquisitions
2. Strategic merger
3. Minority investment / recapitalization
4. Leveraged buyout
5. ESOP (employee stock ownership program)
6. Outright sale

Preparing for a strategic transaction or sale.  Great insight, intention, and effort are often required to prepare a company well for a sale. It is usually a mission-critical, once-in-a-lifetime or once-in-a-career transaction for the shareholders and management.  The process has voluminous and substantial complexities, risk, and potential for extraordinary gain.  Common areas for evaluation, improvement or clean up in preparation for a strategic transaction are described below.  Many companies engage legal, tax, accounting, M&A and other advisors in preparation for a process.

1. Corporate Structure
2. Financial Reporting
3. Operational Considerations
4. Legal Concerns
5. Management Capabilities
   VI. Process for a Strategic Transaction. A sale process for a privately held middle market company requires creating a competitive, confidential market for a highly illiquid security (shares in the company). There are three primary phases of a strategic transaction process, as described below:1. Advisor Diligence and Final Preparation. Completing this phase effectively is essential to avoid surprises and reduce management burden later in the process, and to maximize value.  Diligence and final preparation begins with engagement of an investment banker to conduct the transaction, and a four to eight week period of collaborating with the investment banker for thorough final preparation and thoughtful, tailored positioning of the company.

Led by the investment banker with the company’s input and approval, this can include:
i) creating detailed support for growth initiatives and market opportunity, ii) effectively tailoring the message to each investor or buyer, iii) anticipating and mitigating potential concerns, iv) highlighting specific areas that may help an acquirer stretch on value, and v) anticipating buyer questions and addressing them in marketing materials.

2. Marketing. This phase begins with the company’s investment banker contacting a pre-approved set of potential investors or buyers in the company on a no-names basis.  Over a four to eight week period, the investment banker qualifies buyers based on interest, fit, and capability to fund and close a transaction.  Investors that sign a confidentiality agreement receive the company’s confidential information memorandum and instructions to submit indication letters.  Buyers work with the investment banker to understand the company and how a new owner might grow the business and may request more information that the investment banker coordinates with company permission.

Deliverables and milestones of this phase often include: a) indication of interest letters from buyers, b) management meetings between company and buyers, c) formal offer packages from buyers, and d) an executed letter of intent between finalist buyer and seller.

3. Final Diligence and Closing. Between letter of intent and closing, the buyer takes final steps necessary to effect the purchase of the company.  The company’s investment banker will work with the buyer to construct and execute on a work plan and timeline to close.  This phase typically includes in-depth confirmatory diligence on the company, obtaining financing for the purchase if necessary, obtaining regulatory approval if necessary, purchase agreement and other legal document negotiations, and the close.  It may last one to three months depending upon complexity or simplicity of the company and transaction, and availability of resources from both buyer and seller to move forward quickly.

This final phase goes best when the company has made proper evaluations and improvements prior to the transaction, and when the company works with qualified advisors who have also helped the company prepare well (see prior sections).  Without these two conditions, deals are at higher risk of failing or falling in value during the closing phase.

Deliverables and milestones of this phase include: a) completion of buyer diligence on the company, b) financing of the deal by the buyer if needed, c) execution of purchase agreement and ancillary documents, and d) funding of transaction and payment to sellers.

 

Importance and selection of third-party advisors.  Most middle market companies will fare better in a transaction process by engaging accounting, legal, and M&A experts to structure and coordinate the deal under the company’s guidance.  Shareholders should see a large payback on fees paid to advisors in terms of: i) higher valuation for company, ii) higher certainty of closing, iii) lower risk, and iv) faster and more efficient process than without advisors.

For example, an audit and/or quality of earnings report from a reputable and capable accounting firm, along with the ongoing support of the sellers’ accountants during the transaction process, is critical to demonstrate credibility of financial statements and keep momentum in the deal, as well as to minimize surprises later in the process.  Also, attorneys with seasoned experience and solid track records in M&A transactions are most likely to help the company achieve the best, market-based terms and their knowledge will enhance the efficiency and speed of the process while protecting the sellers from unnecessary risk.

Investment bankers are likely to achieve a higher valuation for the company than it could on its own, as well as: i) organize and manage the process so owners and management can focus on the business, ii) provide comprehensive market-based feedback, iii) enable owners to make fully-informed decisions, iv) advise management and owners on key decisions and market standards, and v) move the process along rapidly while maximizing value and quality.

1. Timing a Sale Process. The evaluation of whether now is a good time for a business owner to pursue a sale or strategic transaction is multi-faceted. Particular shareholder considerations are unique to each situation, and will not be addressed here, but are important to understand and align with stakeholders and advisors.  In addition, key items to consider include:
2. Current company performance. A strong performance trend line, well developed value drivers in the business, strong and clean financial and regulatory reporting and compliance, and established customer relationships indicate the timing is good for a sale.
3. Mid-term company outlook. Indicators of good timing for a sale include favorable industry trends, credible projections for solid growth, and substantiated financial performance.
4. M&A market tenor. Growing sector investment, active strategic buyers, and abundance of capital indicate the timing is good for a sale.

 

Written by Robert Tyndall:  Managing Director of Investment Banking and Corporate Finance at Fifth Third Bank

Fifth Third Securities consists of over 50 highly trained and experienced investment bankers with diverse industry expertise focused on advising shareholders and management of middle market companies in strategic transactions.  For more information, please contact your Fifth Third Relationship Manager.

The views expressed by the author are not necessarily those of Fifth Third Bank or any of their subsidiaries or affiliates and are solely the opinions of the author. This article is for informational purposes only. It does not constitute the rendering of legal, accounting, or other professional services by Fifth Third Bank or any of their subsidiaries or affiliates, and are provided without any warranty whatsoever.

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