Benjamin Franklin is credited with once saying, “if you fail to plan, you are planning to fail”. For investment bankers this saying should hit close to home. Planning is an extremely important part of our job. A plan is needed to determine which types of deals we are willing to work on, how we go about sourcing deals, and how to successfully complete a deal once engaged. In the current bullish market, deal volume across sectors is expected to increase. A recent report from the IBBA shows that business owner confidence is either as good or higher than it was a year ago as reported by 86% of the advisors in the study. With owner confidence high and deal multiples just as high, M&A advisors need to have a plan to succeed.
What happens when you fail to plan? The IBBA report shows that nearly half, 49%, of transactions terminated without closing. While various reasons exist to explain why a deal didn’t close, planning, or lack thereof, was a major factor in the IBBA report. Reasons included poor preparation of the seller’s books (6%), lack of quality offers (6%), financing troubles (5%), and unrealistic seller expectations (12%).
As investment bankers and trusted advisors, we have a duty to our clients to ensure we are well prepared to represent them. This includes conducting through due diligence prior to signing a deal and having a go-to-market plan for if/when the client is engaged.
Any professional and ethical M&A advisor will conduct diligence on a potential client before they fully engage. It is critical to understand how the business works from a financial and operational standpoint. This is to the benefit of both the advisor and client in a few ways. First, it provides the advisor with an opportunity to look under the hood. Surprises in M&A transactions can be a quick deal killer. An advisor should know what they are representing prior to entering the market. Few things are more frustrating than spending months preparing a client for a sell-side transaction, only to have a potential buyer uncover an unpleasant surprise during their diligence. Second, it allows the advisor to ensure this is a deal they can competently represent and have a high degree of confidence they can complete. Both advisor and the potential client would much rather spend some time reviewing the business, then decide it is isn’t a fit, as opposed to engaging, paying fees, and only later determining it wasn’t a good match.
If you are an M&A advisor, the following are some areas to consider for your pre-engagement due diligence. If you are a business owner, pay attention to whether an advisor conducts their diligence. Take it as a sign the advisor is trying to assess fit and doesn’t take just any deal that goes their way.
Naturally, the historical, current, and projected financial health of the company is critical. A well-managed business should have detailed and accurate financials from inception. Not all small businesses will have audited financials and that is ok. However, they should have professionally prepared and reviewed documents to share with the advisor and future buyer. Having your financial ducks in a row will help to speed along future diligence requests from interested buyers. As we have discussed before, rapid due diligence is key for deal closure success. Financials will also be important if the buyer is obtaining third party financing. Incomplete or less than promising financial data could make it difficult to obtain the necessary financing to close the deal. Finally, financials are used to assess the trends of the business. Is revenue growing? How about margins? Buyers will seek to understand where the business has been, where it is today, and where it has the potential to go.
2. Where Do Customers Come From?
A business without customers will not be a business for long. Understanding where customers come from and how they find the business is critical. For example, a brick-and-mortar shop may rely heavily upon foot traffic, whereas an e-commerce business may receive most of their sales from Facebook leads. As an advisor, you should understand where customers are coming from and how this compares to competitors. It is also necessary to determine what percentage of traffic comes from each source. The business will likely be viewed as riskier if a large percentage of customers come from a single source. Buyers will analyze traffic patterns to help project sales, understand the risks involved in losing a channel, and calculating customer acquisition cost. As an advisor, you should be prepared to address these concerns with buyers before the concerns are raised.
3. The Legal Situation
Advisors should seek to understand the legal history of the company. Has the business been a party to a lawsuit in the past? What about the present? Is the company required to comply with specific regulations that a buyer would want to know about? This is certainly not an exhaustive list of legal questions to ask. The key in legal diligence, as in other areas, is to eliminate surprises and ensure their is a good fit between the advisor and seller. As an advisor, you should be considering potential pitfalls that could derail the deal or make the company a less than desirable target.
4. The Seller’s Goals
Every M&A transaction involves humans, so it is necessary to consider the human element of a deal. It will be important to connect the seller with the right buyer and understanding the seller’s motivation for the transaction is critical in achieving this goal. Seek to understand why the business is for sale and what the seller ultimately wants. This will help ensure that you are able to pre-vet potential buyers and only make introductions that make sense for both parties. For example, a founder that simply wants to cash out and walk away is different than a founder who is looking for a recapitalization and plans to stay active post-transaction.
5. Deal Marketing
One of the key responsibilities of an M&A advisor is to connect the right buyers with the right sellers. This is easier said than done. If all your pre-engagement due diligence checks out, a final step before engaging should be determining how you will go to market. Honest and transparent marketing materials and messages will be required. Think about how you will prepare the teaser, CIM, and any management presentation materials.
As an advisor, you should strive to have a complete understanding of the business prior to engaging. Understanding where value comes from, and, more importantly, where future value can be derived will set the exceptional advisor apart from the average. Get familiar with the various levers in the business that a buyer could move to justify the deal. Sometimes this is quantifiable and sometimes it is not. Being able to clearly communicate the hard figures and more obscure opportunities will help a buyer grasp the potential. As bankers, we must remember that part of our job is telling a story of where the business has been and where it can go.
It is difficult to turn down a deal, especially if your deal flow hasn’t been as heavy as you would like. Advisors should have a pre-defined plan for how they will assess deals and make a go/no-go decision. We all want to succeed in the deals we engage with. Have a plan for vetting deals, stick to it, and watch your closing success rate go up.
 Everett, D., International Business Brokers Association, & M&A Source. (2018). Market Pulse Quarterly Survey First Quarter 2018 (Rep.). Retrieved November 8, 2018, from International Business Brokers Association website: https://www.ibba.org/wp-content/uploads/2018/05/IBBA_Q1_2018_final01.pdf