😤 How My Arrogance Nearly Burned A $45m M&A Deal
… a step by step guide to buy-side corporate M&A
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In Today’s Email:
🤧 Bouncing back from COVID
🐳 How Big Businesses Get Bought & Sold
🗓️ A Year on Twitter
I’m back, baby. Recovered from COVID, and feeling crispy again 😎
THE DEEP DIVE
How to Buy a Business: A Step by Step Walkthrough of Buy Side Corporate M&A
This is week 4 in an 8 week season covering the world of M&A from the seat of the CFO
“We’ve decided not to take your offer forward.”
“Yes, we won’t be progressing you to the next round.”
“Oh. You got someone to pay more than our $45m? Fair enough.”
“No. There’s no issue with value. In fact your price is good”
Now I was confused. We were the natural buyer for this business. Our price is ‘good.’ And yet the sell side banker is kicking me out of the process after the second round.
We wanted this business, and the arrogant pr*ck was irritating me.
I tackle it head on.
“Cut the sh*t. What’s the problem?”
“At the start of this process we thought you were the natural owner for this business. And so did our client. You put forward a good bid in the first round, with a normal set of conditions attached, in your letter of intent. So all was good up to that point.”
“Go on …”
“The problem is your approach to the second round. You’ve had six weeks. In that time, you’ve spent less time on the data room than any other bidder. We’d assumed that this meant you had a lower DD threshold. But when we received your second round offer letter, it had all the same conditionality as your first letter. It was basically the same letter with the date changed at the top. And then to top it off you demand exclusivity to finish the transaction. To which our client’s response is ‘no thank you’, we will not progress your offer on those terms.”
It hit me.
The only arrogant pr*ck in this situation was me.
We’d assumed our big bid would be enough to kill off any competition.
I’d not played this well.
“Hello … are you still there?”
I’d been silent for twenty seconds considering whether I should retrain as a plumber or a dentist.
“OK, I understand the feedback. I would like an opportunity to address this. We will submit a revised second offer letter by the end of next week. Could you agree to keep us in the process until then?”
“I’ll have to speak to our client. If you are serious about this deal, you’ve really gone about this badly.”
It was a huge learning experience. I took the reputational ‘L’ on the chin, and came back stronger. I’m still in contact with the investment banker now, and we still joke about the time ‘he taught me how adults do M&A.’
Good process hygiene is vital on the buy-side.
Today we are going to walk that process in detail.
As a quick reminder this is where we are in the full series
Week 0 - Introduction to M&A
Week 1 - The Theory of M&A
Week 2 - Valuation - Enterprise Value
Week 3 - The Deal Team
This is now Week 4 - The buyside process.
The scope for this post is the process for an active deal via a full auction managed by a sell-side investment banker. But to start we are going to touch on the stages immediately before and after an active deal. This will help you understand how an M&A deal fits into the broader business cycle.
Think of it like this:
Longlisting is the process of identifying potential M&A targets. This is a BAU activity that should form part of the business strategy setting process.
It’s important that this is an ‘always on’ process.
A long target list, and a long term mindset helps ensure you only buy when it makes undeniable sense.
Great M&A means walking away nearly all the time.
That’s easier when you know another opportunity is round the corner, and your deal flow is good.
Identifying targets is out of scope for this series. We will cover it in more detail in another series on corporate strategy.
So the important input for today’s post, is that we have a ‘long list’ of targets that are acquisition prospects.
With that, we’ll head into each of the four stages of an active M&A process from the buy-side perspectivce:
Expression of Interest
Conditional Letter of Intent
Due Diligence & Final Offers
Negotiation and Closing
We’ll then close with a word on integration and post-deal (this will get a whole newsletter in a few weeks time).
1. Expression of Interest
Assuming we are starting with a long list of potential M&A targets.
It all starts with an inbound email or phone call, normally from a sell side investment bank.
At this stage, the sell-side investment bank (IB) are in ‘canvassing’ mode. Casting their net wide.
They won’t say much. And they won’t name the business.
They will say something like this:
The first job is to make sure you are on their call list.
Or buyer universe as it’s known.
Their buyer universe will have 3 tiers:
Gold = Strong fit - definite interest
Silver = Good fit - likely interest
Bronze = Tenuous fit - possible interest
It doesn’t matter which part of the list you are on, as long as you are on the list. The key thing is making sure the process doesn’t happen without you.
How do you make sure you are on the list?
This is part of the previous stage; the strategy / corporate development process.
It’s important that the major sell-side banks in your sector know who you are, and what you want.
As CFO you should have good relationships with 2 or 3 investment banks. And at least one sector specialist boutique. Get to know the partners / MDs. Speak to each bank at least every six months, even if you don’t have much to say. They will always take your call. Information and relationships is their life blood, and they get paid on deal success, remember.
There are often 6-8 key personalities in any sector who make and broker the big deals.
Know them, and make sure they know you.
This is a significant benefit of having sector specialism as a CFO. It will be the same people, even if you move companies. Cultivate these relationships.
They are often unlikable show-offs, but they are important, so learn to like them.
You should also keep direct relationships with key targets where you can. Some of the best deals I’ve done, didn’t use an investment bank at all. They got done ‘off-market.’ Folklore will tell you this doesn’t happen or doesn’t work. But the folklore in M&A is all written and told by the investment banks…
So, you have received your inbound. You’ve spoken to the sell-side, and you’ve decided you want to progress in the process.
Non Disclosure Agreements
You will likely be asked to sign a Non-Disclosure Agreement at this stage. Nine times out of ten, I sign an NDA as it’s presented. You can lose a lot of time, momentum, and goodwill passing an NDA back and forwards between lawyers. It’s a great way of signaling you don’t know how to control your lawyers, and will be a nightmare to deal with at the sharp end of an M&A transaction.
In my career to date, I’ve signed close to a thousand NDAs. Occasionally I’ve seen them breached, yet I’ve only ever seen legal remedy from an NDA once.
Their value comes as
a) a deterrent
b) a signal that everything that is shared from now onwards is confidential.
So don’t waste time negotiating the terms of an NDA to death.
Once you have signed the NDA, you will be told the name of the target, and often provided with a teaser. A teaser is a short document (3-5 pages) which outlines the details of the business. Often with the juiciest details redacted.
Now it’s over to you. You know who it is, and have some basic details on the business. You need to decide if you are interested or not.
And that means committing to the next round of the process. Which means time and cost.
Written Expression of Interest
Assuming you want to go forward, you submit a formal written expression of interest. A short note confirming:
You are committed
Why you are interested
That you can fund the transaction
Any timeline or resource considerations.
The sell-side IB will coordinate similar responses from every party in their buyer universe. The whole process takes 2-4 weeks.
Once that is done, they review the responses with their client. And then decide who they want to take through to the first round of the process.
That means agreeing who they share the Confidential Information Memorandum (CIM) with.
2. Conditional Letter of Intent (LOI)
Assuming you didn’t mess up stage 1, you will get confirmation from the sell-side IB that you are through to the first round.
I always like to receive this feedback over the phone. You can harvest valuable intelligence from these back channels. I’ve caught many valuable nuggets down the years by asking good open questions over the phone.
You will get issued with a ‘process letter’ at this stage. It explains all the specifics of the process; timelines, key dates, offer deadlines, what information is available and when, etc.
Respect the process letter. This was the mistake I made in the example I gave at the start of the post. I failed to respect the process, and it nearly cost me the deal.
It is likely the first key deadline is a ‘non-binding offer’, or ‘conditional letter of intent’ by a certain date. You will have 4-6 weeks.
That means using the available information to build an offer. At this stage you are not testing the accuracy of the information provided. That comes in the next stage.
CIMs and Data Rooms
To advance this stage, the sell side IB will give you:
Confidential Information Memoradum (CIM). Big slide deck (50-100 pages) that is the sales brochure for the business.
Access to the Dataroom. Imagine it like a very well controlled sharepoint site. Where all the detail on the business are held; financials, sales, customers, products, purchasing, employees, operations, legals, etc
Commercially sensitive information (pricing, etc) will be held back until a later stage.
Vendor Side Due Diligence Reports (More on this when we discuss the sell side process in 3 weeks time).
A process for submitting any Q&A (not yet answered the data room)
The key thing at this stage, is using the information to build your business case. And defining the assumptions on which that business case is built.
Whatever valuation method you are using, this is where you flesh it out.
Your goal is to build:
valuation model (internal only)
business case memo (4-6 pages) which provides the acquisition rationale (internal only)
funding plan for deal
conditional letter of intent (external)
You must use your memo to align your internal stakeholders to your valuation and conditional letter of intent (likely your board). You can submit you letter of intent to the sell-side IB, ahead of the deadline set out in the process letter.
Submitting a Conditional Letter of Intent
Here are the contents of a good Conditional LOI
Confirmation that the letter is non-binding.
Why you are interested in the target
Amount. What are you offering for the business?
What is the rationale (often a multiple of EBITDA or EBIT). You will state an assumed ‘proforma EBITDA’ on which your offer is based, with the current proforma EBITDA being the biggest focus of your DD in the next stage
Assumptions (that need testing in due diligence)
Form of consideration
Stock vs Cash
Timing of cash payments
Statement of how you will fund the transaction (a ‘sources and uses of funds analysis’)
Attach any proof of funds (evidence of equity funding, letter of funding intent from banks)
Conditionality - Set out what your offer is contingent upon
Internal Approvals. Is your offer Board approved, or not? If so, you should say so, it adds credibility.
Anti-trust. Do you expect any anti-trust issues with your acquisition. If so, how do you propose they are handled.
Financing. If you are raising new debt, your transaction may be conditional on securing that debt
Due Diligence. At this stage your offer will be subject to due diligence, but try and be as specific as possible.
Final Documentation. Your offer at this stage will be conditional to agreeing the legal documentation
Others. Anything else? The more specific you can be here the better.
Timeline To Close
What is your expected timeline to close the transaction. Can you meet the timeline set out in the process letter?
How do you propose transaction costs get handled for the next stage? Normally each party bears there own costs. But you can ask for cost coverage if you feel you are being led on by the sellers and want evidence of their commitment to your offer. You can ask for exclusivity, but it very likely will not be granted at this stage in a competitive process.
The Conditional LOI is very important. Yes the number matters, and it’s always the first thing people will look for, but then they will read every word. Every component of your offer will get compared to your competitive bidders. Be credible, and professional.
With your LOI submitted, it’s a waiting game to see if you get taken through.
3. Due Diligence & Final LOI
You submitted your conditional LOI, and at this stage the feedback you get will be binary. You’ve either got through to the next round or not.
The sell-side team have to make a decision on how many to take through. It is unlikely to be more than 2 or 3.
Gather all the intelligence you can through back channels and side conversations with the sell side IB.
This will help you find out what they like and don’t like about your offer. Try and find out how many are in the process. If they have concerns about your ability to fund the transaction, this is when you’ll know.
Use what you hear to focus your next stage of work.
Because the next stage is where deal costs start to ramp up. That’s ok if you win the deal, but you aren’t the only party here, you could end up spending millions on a transaction you don’t win.
In the previous stage you were taking the information provided as a given. In this stage you are testing the accuracy of the information provided. That is expensive.
Depending on how complicated the deal is, you will likely have 6-12 weeks for this stage.
It is important that you concentrate due diligence on things that matter. The things that direct affect the viability of the deal. Like the example I provided in the first week of this series.
Legal Due Diligence
Legal due diligence (LDD) is the process of investigating legal past and present of the Company for any legal risks. If a large liability emerges for the company after the transaction, you need to make sure the previous owners are on the hook for it.
Your legal advisor will be the expert and will help define the LDD scope. We talked more about how to pick them, last time. You should coordinate the LDD review through your in house general counsel. You are only interested in exceptions and issues.
Financial Due Diligence
Financial Due Diligence (FDD) is the process of examining the financials of the business in great detail. These tend to focus on past (historical trends), present (current proforma performance), and future (forecasts).
I prefer to focus FDD efforts on current performance, as that is the basis I use for valuation.
In particular I like FDD to focus on current underlying earnings performance. There is only so much value in having PwC tell you what they think about the accuracy of a forecast. These guys have never run a business, so how a business responds to circumstance is all educated guess work for them.
Where they are very useful though, is on understanding deeply current and historical trends. And focusing deep on the quality and direction and current earnings.
We use a Quality of Earnings Review to do this. And it’s so important, we are going to dedicate a whole newsletter to it next week.
Your aim in this stage of the process is to remove as much of the conditionality from your offer as possible. It was my failure to show this that nearly cost me in the example I started the post with.
Management Presentations and Site Visits
In this stage you will have access to management, and visits to site. This will mostly be stage managed and quite formal. But target management are often not used to these processes. So given a change will say things they shouldn’t have said, which is good for you. If you can pick them off in one-to-ones and side conversations, you should do so. You will learn a lot. Nice open questions. “Hey, how have sales been the last couple of months?”
Whilst all this is happening, you will also have to raise commitments for any new funding needed. At the LOI stage you had to share your intent around how the funding would come togehter.
At this stage, you need to get investors to provide binding commitments to give you the money you need for the deal. I.e. if you plan to fund a $100m transaction with $60m of new debt, it’s no longer good enough to have intent to fund. You need to work with your banks to turn that intent into a commitment letter.
The seller will expect to see commitment letters from investors to fund the total deal. They want the funding uncertainty removed by this stage. The fundraising process is not in scope for this series, but we will tackle it in a future series.
Through this stage you should be on:
daily internal project meetings
thrice weekly updates with advisors
once per week updates with the Board.
You are at the sharp end now.
Unconditional Letter of Intent
The end result should be a revised Letter of Intent submitted before the deadline.
This should follow much of the same rules as we set out in the previous section, but should now:
Provide concrete proof of funds. Evidence of committed funds required to close the transactions
Remove much of the conditionality from your offer. That was the purpose of your DD.
Commit to a cleaner valuation too. Use DD to remove uncertainty from your valuation. You should now have landed on what you think proforma earnings are from the result of your DD. So should state what that number is and how you have calculated it. So be clear on what your $ offer is, and based on what proforma earnings.
Set out what remaining work you have before closing
Timeline and conditions to closing (should be a much smaller list than the last round)
4. Negotiation and Closing
You are in the home straight now. If you are still in the process, you should assume you are in the box seat. This is where negotiation of the fine detail of your offer starts.
The sell side IB will be trying to convince you add back those things you struck out of the proforma EBITDA. This is all an effort to increase the price.
The process can get a little foggy here. You are about to trigger an avalanche of deal costs, so its important you know exactly where you are.
You flush this out by demanding exclusivity on negotiations. This is normally a 4-6 weeks period whereby the seller agrees only to deal with you. You will only get this if you have behaved credibly, are the high bidder and shown you are serious. If they agree, it’s a good sign that everyone wants your deal to happen.
If you get that sign, it’s heads down to get the thing over the line.
This means working at a break neck pace, often with 18-20 hour days and through weekends to get it done.
Who said M&A was glamourous?
Negotiating Legal Documentation
Now is the time to negotiate the detail of the legal documentation; i.e. the share purchase agreement and all ancillary documents. This process is painful and can feel never ending. There could be several legal agreements to negotiate depending on the structure.
You will end up on 11pm calls with lawyers debating some point of detail on an exclusion on the liability clause, or similar. You need to use what you learned from DD to decide what is important for the contracts. This is where the knowledge of the business, and the deal will become important.
It's all about where the risk associated with a deal sits. You (or someone) will need to make some snap views on these points of detail. Knowing what you should / shouldn’t agree (under advice from your legal advisors) is the hard bit. It comes with experience.
Keeping a running list of negotiation points is important. Balancing being a hard ass with trying to get the deal done is the key. We’ll cover negotiation another time.
From Enterprise Value to Equity Value
In this stage you will also need to convert your offer from an Enterprise Value (cash free and debt free) to equity value. An actual $ value you will pay for the equity of the business you acquire. This also means tackling the treatment of working capital (a minefield)
We will cover this part of the process in more detail in a few weeks time. It’s so important, we will dedicate a whole newsletter to it.
Confirmatory Due Diligence
You will have the opportunity for final ‘confirmatory due diligence’. This means checking that nothing has changed since your DD. The seller will provide a trading update, with the very latest performance. Your last offer will have been subject to this confirmatory DD.
If performance of the business has traded away from your assumptions, this is where you address it. Careful renegotiating the deal though, if you do that too liberally, you could lose the deal and your credibility.
This might also be the first opportunity you get to see certain sensitive information. Pricing etc.
Alongside confirmatory due diligence, and finalizing the contracts, you will have a bunch of closing formalities to sort out. Announcements to agree with the other side, handover plans for day 1, etc.
By this stage everyone involved has ‘deal heat’ and wants to get it done. Shrewd negotiators use that deal heat to secure additional value in the deal.
And if you get that far, and get it signed… congratulations.
That’s the easy bit done…
There are some deal related post completion matters to think about. But your advisors will mostly take care of those.
Your focus should be running and integrating the new business you just bought.
But that is a whole topic in itself, and we will dedicate the final week of this series will to how you do that.
Maintaining a disciplined process with clear stage and gates is the key. The fees and commitments grow exponentially as the deal goes on. So being precise about what is being done in what stage is extremely important.
Aborted M&A is expensive, as is poorly executed M&A.
M&A pros get the balance of risk right at each stage and use the process and their advisors to manage it.
And for those wondering what happened to the $45m deal I bodged… the seller let us back in the process. We did win the auction and the deal, despite my awful process management. I got lucky, lived and learned.
Next time we will talk about Quality of Earnings. This is probably the most important piece in this series.
THIS WEEK ON TWITTER
It is now a year since I made my Twitter debut. As you can see, I really got off to a bang a year ago:
A wonderful way to present financial flows
— The Secret CFO (@SecretCFO)
Aug 13, 2022
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Next week. Quality of Earnings. It’ll be a good one.
Until next time…
The Secret CFO
Disclaimer: I am not your accountant, tax advisor, lawyer, CFO, director or friend. Well, maybe I’m your friend, but I am not any of those other things. Everything I publish represents my opinions only, not advice. Running the finances for a company is serious business, and you should take the proper advice you need.