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Tip of the Spear Ventures

Venture Capital | Private Equity

Due Diligence

Mergers & Acquisitions: Slowing Down to Speed Up! Part 2

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The Point: When it comes to Mergers & Acquisitions, speeding up isn’t the answer. In fact, I typically see that if those that lead M&A would simply slow down, they actually achieve their objectives more quickly! So how then do Mergers & Acquisitions leaders and their teams slow down for success? In this two-part post (You can read Part 1 by CLICKING HERE), we’ll explore exactly how slowing down to speed up can be achieved in Mergers & Acquisitions… Enjoy!

In Part 1 of this post on “Mergers & Acquisitions: Slowing Down to Speed Up!” we explored how slowing down to speed up can be achieved in Mergers & Acquisitions. Specifically, we reviewed the effect of COVID-19 on M&A, a six (6) stage Mergers & Acquisitions Strategy, and how slowing down to speed up can result in M&A success. Here in Part 2, we will continue the discussion on potential challenges and how to navigate them.

Pricing Flexibility and Fairness

As mentioned in Part 1, a key issue when negotiating an M&A deal is the agreed to pricing mechanism or structure of the deal and related adjustments to be made. Know this: There is almost always a difference between what the Seller believes is the appropriate price and what they Buyer believes they should have to pay for a business. This valuation gap should contain contingency planning on how to deal with differences in lock box (fixed price plus an interest component), working capital, capex, and net debt adjustments and Seller Discretionary Earning – SDE or earnout.

The Breakup Clause or MAC

As a Buyer of businesses, we typically like to include clauses that allow for a clean “breakup” if need be. There’s considerable time and investment made, and nothing is worse than an ugly breakup! Including a Material Adverse Change (MAC) condition whereby “walk-away” privileges are preserved.

Keep in mind that a MAC should be used as a Buyer’s protection tool in the event significant differentiation presents itself in asset deterioration versus stated condition for example. A MAC should not be utilized as a “cool down” or buyer’s remorse prevention tool.

Targeted Due Diligence

The main issues identified for the business should be included in a targeted due diligence approach. This approach could be further supported by identifying and putting into place Representations and a Warranty & Insurance policy. These policies are used in Mergers and Acquisitions to protect against losses arising due to the Seller’s breach of certain representations made in the acquisition agreement.

With so much to consider when it comes to a Mergers and Acquisitions due diligence initiative, where should you start? In other words, if you don’t have a target to aim for, you’ll never know if you hit or miss it! Consider this due diligence moment as one similar to a VC exploring a Series B round investment. Here then is a list of 8 items to target as a part of your due diligence:

  1. Corporate Records and Charter Documents
  2. Business Plan and Financials
  3. Intellectual Property
  4. Security Issuances and Agreements Concerning Securities
  5. Material Agreements
  6. Information Regarding Disputes and Potential Litigation
  7. Information Regarding Employees and Employee Benefits
  8. Equity Grants

Competitive Analysis

A competitive analysis is a strategy where you identify major competitors and research their products, sales, and marketing strategies. By doing this, you can create solid business strategies that improve upon competitor’s market position. We recommend conducting a Competitive Analysis as part of your due diligence, primarily because you’ll need to identify the current role the organization plays within the existing business climate, as well as where potential lies.

In conducting a SWOT Analysis (Strengths, Weaknesses, Opportunities, and Threats), we recommend a deep-dive on competitors. You’ll need to identify who you’re really competing with so you can compare data accurately (An apple vs apple comparison, even if it’s two different varieties of apple is better than an apple vs orange comparison). Specifically, you’ll want to identify:

  1. Who are your direct competitors (Those competitors you that offer a product or service that could pass as a similar substitute for yours, and that operate in your same geographic area).
  2. Who are your indirect competitors (Those that provide products/services that are not the same as yours, but could satisfy the same customer need or solve the same problem).

Competitor analysis is something that you’ll also want to revise throughout the years of ownership. Why? The market can and will shift anytime, and if you’re not constantly surveying the competitive landscape, you won’t be aware of changes until it’s too late.

SUMMARY

In this post, Mergers & Acquisitions: Slowing Down to Speed Up! Part 2, we explored how slowing down to speed up can be achieved in Mergers & Acquisitions. Specifically, we reviewed Pricing Flexibility and Fairness, The Breakup Clause or MAC, Targeted Due Diligence, and Competitive Analysis.

Sam Palazzolo

Mergers & Acquisitions: Slowing Down to Speed Up! Part 1

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The Point: When it comes to Mergers & Acquisitions, speeding up isn’t the answer. In fact, I typically see that if those that lead M&A would simply slow down, they actually achieve their objectives faster! So how then do Mergers & Acquisitions leaders and their teams slow down for success? In this two-part post, we’ll explore exactly how slowing down to speed up can be achieved in Mergers & Acquisitions… Enjoy!

The Effect of COVID-19 on M&A

The pandemic has certainly had its impact on the economy. From lockdown mandates to the rebooting of the economy (and sometime unfortunate re-lockdown occurrences), we’re seeing a major effect on the bottom lines of organizations we’ve determined as prospective M&A market verticals. Even with the hope of antivirus on the not too distant horizon (hopefully!), there exists a number of companies that will be pressured by creditors to divest assets to pay down debt and avoid going into business rescue (or liquidation), or to assist in funding ongoing operations due to a cash flow crunch.

With abbreviated timelines, M&A activity now additionally has certain legal and commercial challenges for both buyer and seller at play. Think asset preparation for sale issues give the shortened timeline, providing the buyer with accurate information and time to conduct thorough due diligence ultimately sets the stage for deeper valuation gap analysis.

If money is made during the initial acquisition moment, the buyer must mobilize funding for quick deployment while the seller balances the need for speed and complexity of the divesting process.

Mergers & Acquisitions Strategy

In order to speed up, we’re going to have to slow down. A strategy to help accomplish that is to view the Mergers & Acquisitions Strategy from the Seller’s perspective. With the Seller’s perspective in mind then, the following is a six (6) stage strategy a Seller could employ to make the transaction a reality:

  1. Business Valuation – What multiple (typically 3-5x) applied against what financial term (Cash flow, Seller Discretionary Earning – SDE, and/or EBITDA)? Additionally, taking into account current COVID-19 financial performance considering revenue, expenses, and liquidity are important business valuation determinants.
  2. Deal Structure – What will the proper deal structure look like? From a financing perspective, will it be made up all/parts institutional/non-institutional financing (Banks, Private Equity – PE, Family Office funding), seller financing, and/or buyer funding? Additionally, will there be a need for the seller to provide a transitional services agreement whereby they agree to stay/run the entity during the transitional period typically of 3-36 months?
  3. Business Listing/Auction – As a seller, you’d like to receive the most money for your years of service to an organization. What is the best route to get the most money then? Typically, we approach organizations not listed for sale prior to them listing their business. With these Sellers, they typically don’t know how much their business is worth. Introducing them to a valuation service can be beneficial in determining the value of their entity as well as a potential source for realistic listing of the company. In some situations, businesses are already listed for sale on sites such as BizBuySell.com. Lastly, in distressed situations a business will go to an auction sale process.
  4. Legality – There typically is involved a series of professional advisors (I wrote about surrounding yourself during the M&A process in a post that you can read by CLICKING HERE). Know that as a seller disposing of assets sometimes there is a need for disclosure of key regulatory approvals that may be required to implement the divestment. Understanding these issues enables a seller to (1) be forthright about any problems associated with the organization’s assts and (2) accelerate the due diligence timeline towards the creation of an acquisition agreement.
  5. Buyer Qualifications – Who is going to be the ideal buyer of the business? Most owners have a variety of Buyers approach for acquisition. However, not all Buyers are created equal, and therefore should not be considered as such. Typically, there is a Buyer profile that can eliminate potential Buyers and provide a strategy for who the owner ideally would like to see carry on their legacy.
  6. Leveraging Technology – If the pandemic has taught us one thing, it’s that virtual meetings can maximize your efficiency if conducted properly. Therefore, leveraging technology (virtual meetings, email with clear communications, etc.) can greatly enhance the offerings value to Buyers.

Slowing Down to Speed Up for M&A Success!

So what is your goal regarding established Acquisition Strategy (You can read Tip of the Spear Ventures Acquisition Strategy by CLICKING HERE). Our goal at TIP is to acquire one (1) business each quarter. That’s a lofty goal, and requires numerous business explorations to be conducted each month. But with such a goal, we know that speeding up isn’t the answer. In fact, we’ve found that if we simply slow down the acquisition process we achieve our objective more quickly.

Speeding up wasn’t the answer for us! With speed came a host of issues, such as increasing complexity, unnecessary energy consumption, and overlooking of key due diligence criteria. We also found that we were quick to “fall in love” only to be heartbroken because we overlooked obvious signs that the business wasn’t a good fit for our portfolio.

By slowing down, we were able to go deeper in our due diligence. As a result, we dealt more effectively with the typical increased levels of complexity, overcame easier the obstacles/challenges that presented themselves along the way, and used far less energy. Not only were we able to go deeper, but speed was attained so that we could go faster towards achieving our goals/objectives.

SUMMARY

In this post, Mergers & Acquisitions: Slowing Down to Speed Up! Part 1, we explored how slowing down to speed up can be achieved in Mergers & Acquisitions. Specifically, we reviewed the effect of COVID-19 on M&A, a six (6) stage Mergers & Acquisitions Strategy, and how slowing down to speed up can result in M&A success.

Sam Palazzolo

PS – In “Mergers & Acquisitions: Slowing Down to Speed Up! Part 2” we’ll discuss Pricing Flexibility and Fairness, The Breakup Clause or MAC, Targeted Due Diligence, and Competitive Analysis. You can read it by CLICKING HERE.

Business Acquisitions – Initial Due Diligence Considerations

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I recently participated in a Business Acquisitions roundtable discussion. The roundtable was made up of acquisition entrepreneurs well known for their roles in company growth and market consolidation. As a result, these successes have afforded these entrepreneurs to live lives with considerably more independent lifestyles (especially for the more well-capitalized entrepreneurs present – perhaps a topic for another post). One of the topics discussed at the roundtable was from a participant’s question, “What considerations should I have when conducting due diligence during the business acquisitions process?” Often times, failed deals are the result of a lack of conducting thorough due diligence on key information items on the buyer’s part. The questions like those below in the areas of Seller, Market, Financials, Legal, Environment and Personnel are initial considerations that should not be overlooked:

About the Seller

Learning as much as possible about the seller’s motivation for exiting in order to provide important insight into what their exit target is. Questions to ask regarding seller due diligence include:

  • How was the business started?
  • Why is the business for sale?
  • Is the seller selling the entire entity or just the assets?
  • Is there a business plan in place?
  • What keeps the seller up at night?
  • If the seller is involved in the business: How much salary does the seller take (now/after acquisition)?  How much vacation (now/after acquisition)?

About the Market

A few questions about market due diligence:

  • What is the size of the market and what market share does the acquisition target hold?
  • To what level can the acquisition be grown to?
  • What are the biggest challenges to growth?
  • Who are the industry leaders (local/national/world)? Is the company considered a market leader in any aspect?
  • Does the product or service have a life cycle, or seasonality?
  • What would the business’ customers and competitors say this business does best?

About the Numbers

More than anything else, it is important to thoroughly understand the financial due diligence of the prospective business acquisition. To determine if the seller’s claims are supported by the figures, ask to review three to five years of history and future projections:

  • Sales
  • Revenues
  • Gross margin
  • Cost of Goods Sold (details)
  • Earnings before interest, taxes, depreciation and amortization (“EBITDA”)
  • Capital investments
  • Taxes
  • Accounts receivables
  • Accounts payable
  • Inventory

About Legal Issues

To avoid hidden surprises, it is important to dive into legal due diligence issues in the company, including:

  • Any possible future lawsuits (If so, due to what?)
  • Is the business location owned or leased (If leased, what are the terms?)
  • Is there proof all taxes have been paid?

About the Environment

Conducting environmental due diligence is a crucial initial step. Governmental guidelines can levy responsibility for environmental issues that existed prior to the current ownership. Find out about any hazardous materials/waste disposal or other environmental considerations that must be taken into consideration.

About the People

If purchasing more than just the physical assets of a company, a potential buyer should understand key personnel issues such as:

  • Who else (besides the seller) has equity ownership in the organization?
  • What employment agreements are in force (FTE/Contract)?
  • What role do other family members play in the business?
  • Who are the key people, what do they do and why?
  • Which key employees are most likely to leave if there is a sale, and why?
  • How well documented are the business processes?

Summary

Business acquisitions are a better way for entrepreneurs to go into business versus startups. However, with that said the business acquisitions market still is littered with deal casualties (Even with showing considerable upside versus startup entrepreneurship). Taking the time to conduct the proper due diligence is the key. Due diligence in the areas of Seller, Market, Financials, Legal, Environment and Personnel are initial considerations that should not be overlooked.

Sam Palazzolo

PS – My firm is actively pursuing business acquisitions of small businesses ($1-$10Million Annual Revenue). If this describes you/your business and you’d like to inquire about our business acquisitions process, email selections@tipofthespearventures.com.

What Makes M&A so Difficult to Execute Successfully? Top 3 Reasons!

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The Point: Visualize a scenario where you buy a used car… There were test-drives available, you could examine both interior/exterior, even seek assistance from a trained mechanic to help assess the performance/stability of the car. Now, irrespective of all due diligence, the real fact is, whether you made a good purchase or otherwise, you will get real evidence after the purchase is made once you start riding around in it over time. Mergers &acquisition deals also have the same route and challenges – you can examine the existing business based on visible financial numbers, assumptions of potential fitness and advisory assistance from M&A advisors. With all these though, it’s only when all deals are made and the business needs to be moved forward that reality sets in – the dreaded difficulties and challenges may arise. In this post we’ll talk about what makes most mergers and acquisitions difficult to operate successfully… Enjoy!

What Makes M&A so Difficult to Execute Successfully?

Why Most Mergers & Acquisition Fail

Most people have read studies reporting the failure of most acquisitions to provide shareholder value – yet there have been an increasing M&A market with frothy valuations, not lacking willing buyers to venture.

A purchase with a high price often increases the task of creating a higher value. For the last decade, it has come to the understanding of many buyers that value is created from building real business value and NOT just from mere clever financial engineering and opportunistic buying.

Acquiring growth from new markets, customers and products are the major purpose for most mergers & acquisition – for profit maximization through the strategic potential of a deal. But are most firms really getting all of these? Statistics have confirmed it not to be the case. Discussed below are the reasons why executing M&A successfully can be difficult.

Top 3 Reasons Why Successfully Executing M&A is so Difficult

Reason #1: Not Executing the Integration Process

The post-merger integration has been a major challenge for many mergers & acquisitions deals. In order to identify crucial projects or products, key employees and all sensitive matters, there must be a well structured appraisal process in place. With this in place, there should also be a design for efficient integration/adoption of processes that will be supported with automation, consulting and possible outsourcing alternatives (so as to avoid deal complexity).

Reason #2: When Owners are NOT Involved

Most of the time, a limited role is assigned to advisors until a deal is completed. With this being made known, newly acquired entities are onus of their owners (or without). There should be involvement from owners starting from the establishment of the deal, to how the business will run and should allow advisors to play a role assisting (if need be). This will have a lifelong benefit to the organization as the owner will benefit from the experience of gaining tremendous key knowledge/insight and the all too important ability to execute.

Reason #3: Assuming Optimism Blindly

It is very common for buyers to assume that a targeted company operates just as the way they do things themselves. It must be noted that there are a lot of different approaches of operational functions by which companies operate by. The integration team should account for these differences when plans are being made. They should consciously make the right assumptions rather than aggressive ones.

We’ve worked with a large client for several years now… While each has the same corporate logo hanging out in front of their business, each operates dramatically different from one another on the inside!

SUMMARY

In this post we’ve discussed the topic of mergers & acquisition, and more indepth what makes M&A so difficult to execute successfully. From an outsiders seat there appears to be a need to enhance deal-making skills for acquiring a new business if lasting success is desired. A potential great company will learn from the three reasons given of mistakes made by rookies and improve, integrate the right process where owners will be involved, and consistently build capabilities needed for future growth.

 

Sam Palazzolo

PS – If you/your organization has challenges as a result of Mergers and Acquisition activity, please don’t hesitate to drop me a line and request future post titles! Here are a few other titles that are currently in the works:

  • Will Your M&A be a Success or Failure? 3 Tips!
  • Disrupting Your Industry with Exponential Growth: How Amazon’s Purchase of Whole Foods Upended Retailer’s Strategic Plan
  • Mergers & Acquisition: Should You Go for Stock or Cash?
  • The Importance of an M&A Strategic Plan
  • Mergers & Acquisition: Creating Shareholder Value
  • Mergers & Acquisition – Six Diversification Questions
  • Mergers & Acquisitions: The Future in the Old/New Economy
  • How to Successfully Survive Mergers & Acquisition
  • Mergers & Acquisitions: The Problem with Acquisitions