Buyers: Bridging the Business Value Gap
This post is the second in a series outlining how buyers and sellers can bridge the business valuation gap.
A number of macroeconomic factors are playing into the higher corporate valuations of today’s mid-market business deals. A good environment for IPOs, strong corporate balance sheets and cash positions, and general availability of buyout capital are having an upward impact on the value of private deals. Company acquirers, particularly if engaged in a buy-side transaction, are finding themselves paying more of a premium than in any other time since 2007. It makes it difficult to maintain buy-side discipline when the pressure to put capital to work is strong. Maintaining that buyer discipline is key as most deals can and should be accretive to the buyer. The following pointers may prove helpful.
Dealing with Higher Valuations
- Higher multiples require more in-depth due diligence of acquisition targets. Higher prices create a scenario of increased risk to M&A success. Having the right due diligence team in place to assist is paramount to such a transaction, to ensure the skeletons are pulled from the closet.
- Financial buyers have even higher risks when valuations become bloated. Strategic buyers typically have a more in-depth understanding of the business while financial buyers are more exposed to the business risks that come with lack of tacit industry-specific knowledge. If you don’t know the industry, best to find someone that does or move on.
- Restructuring isn’t as effective as it once was. Today’s deals—particularly those that are for sale in a premium auction—should be reserved for those with the greatest strategic synergies to the buyer. While financial re-engineering is still a possibility, the 80’s and 90’s have helped to eek out many of those efficiencies from traditional mid-market operations.
- Focus directly on proprietary dealflow. While often bad for sellers, proprietary deals should be the pinnacle for business buyers. Buyers should also work to increase overall internal dealflow. Feeling forced into a deal because of lack of other options is a terrible strategy. Still the best source of deal flow comes from investment bankers running a through buy-side process on your behalf
- If the buyer is public, use of stock with a high P/E ratio as consideration for the transaction could be the best move of all as most deals will be accretive to the buyer. For one, it avoids the need to shell out cash directly and it allows the buyer to take full advantage of the current overvaluation in the market.
- In the end, buyers should always have the discipline to sit on the bench, if need be. As I say regularly: “you make your money on the deals you don’t do.”
Rapid Due Diligence
As both buyers and sellers become more sophisticated, LOI’s and Purchase & Sale Agreements become shorter and more succinct. Consequently, more stringent due diligence is being matched with equally disciplined post-LOI negotiations. From the buyer’s perspective, this approach can be time-consuming and costly. Unfortunately, it is also very necessary, particularly if a premium is being paid for the company. Understanding which due diligence areas serve as both bottlenecks and increased cost areas are paramount to the entire process. While there are ways to perform the necessary due diligence rapidly without incurring greater unwanted costs, difficulties remain. What follows are some potential pointers to help keep on task during the DD phase as well as keep costs and timing in-check.
- Engage with expert outside help earlier in the process before you even reach the DD phase. This includes investment bankers, valuation experts, wealth managers, attorneys, tax consultants, CPA’s etc.
- A cohesive deal team is helpful, particularly one that has worked through the various pain points of deals in the past. The deal team could include a hybrid of both outside M&A advisory and inside expertise.
- Have an organized DD roadmap and Gantt chart in place long before DD actually begins speeds the process and yields better results. Being organized when the gate opens can mean you save days and weeks. In deal speak that could mean the difference between consummating or not.
- The general rule in the past was that smaller deals require less DD. I would clarify that deals with below market valuations sometimes require less DD because the risk is mitigated in the price and smaller business are often less complex. However it is best practice with smaller deals, particularly those with less organized management, to require even more scrutiny when it comes to finding the skeletons in the closet. Taking your eye of a smaller deal can open up larger risk.
- Ensure the sellers’ expectations are in check for the DD process. The level of data required is often overwhelming, particularly for those who’ve never run through DD before. Pre-selling and preparing sellers for the process long before it begins can help keep expectations in check.
- It may go without saying, but start DD early. If possible, begin some of the preliminary items before the LOI is executed. The quicker the unpleasant surprises come to the surface, the better both sides will be prepared to deal with such issues.
- Keep it short. Definition of short: 30 days, but no longer than 60 days if you can…organization and preparation are key. We’ve spoken about rapid due diligence before.
- Buyers and sellers often use reps and warranties as a method for resolving issues and differences in the transaction or limiting expose. Where possible, these differences should be resolved in deal terms and other ways. In most cases, it helps to focus more on indemnifications rather than reps and warranties.
- If acquiring a company offshore, it is wise to have representation that is within country on the team as well as your local representation. Loyalty to the country as well as an understanding of local laws can be a good qualitative deal factor. Most reputable investment banking firm will have relationships globally to assist in this process.
- Do background checks and investigations on the selling management. It helps to know who you’re dealing with.
- Lastly, bring your integration team into the deal and due diligence process early as they will be ultimately responsible for capturing the synergies and ultimate ROI of the deal. Getting these folks in early can avoid many a re-start and can help overcome a lack of ownership in the process on an “inherited” deal.
The aforementioned pointers are not meant to “squeeze blood out of the stone,” but they may prove helpful in avoiding some of the headaches associated with any deal. As any dealmaker will attest, transactions are never easy. Even the smoothest deals, have speed bumps, hiccups and the occasional heartburn. Several certainties remain. Firstly, preparation precedes success. Second, despite the best preparation, deals can head down a path wholly unintended by both buyers and sellers. Third, regardless of how many times you’ve done deals, you always learn something from the process. By using a licensed investment banker you can avoid many of the costly learnings and benefit from their experience
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- 2021 Outlook on Media & Telecom M&A Transactions - May 12, 2021
