M&A Essentials: The Sale Process Part II — The Key Stages– November 15, 2019 by Jim Lisy

In this installment of our “M&A Essentials” series — offering a fundamental understanding of the concepts, issues and processes every business owner should be familiar with when considering and conducting the sale of a business — we focus on the nuts and bolts of each stage in the sale process.


Now that we understand the players involved in an M&A deal, let’s focus on the process. There is a common progression of stages that characterizes most acquisitions, as shown below.

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Planning

Even before the deal team is established, it is critical to define the expectations of the shareholders. Their expectations should drive the objectives of the process and keep the team in focus. Among the topics to address early on are: 

  • Value expectations,
  • Liabilities retained by sellers and acceptable indemnifications,
  • Expectations for the post-divestiture roles of management, and
  • Potential deal structures (asset versus stock sale, and full sale versus partial or leveraged recapitalization).

The development of the marketing strategy for the sale of a company is also a crucial theme that cuts across the entire process. The most important question that must be answered is: Why would someone be interested in buying the company? Other questions include:

  • What messages will entice strategic or financial buyers?
  • What are the elements of value?
  • Is the company a good stand-alone investment or is it an element in a buyer’s larger strategy?
  • Does the company’s value depend on a competitor’s willingness to gain market share through the purchase of the company?

Once this thesis, or multiple variations of the thesis, is developed, it is important to carry that theme through the entire marketing process.
 
Finally, planning should include establishing deal procedures, including assigning responsibilities, gathering contact information and establishing communications procedures. Detailed planning is important and helps ensure confidentiality of the process by eliminating the risk of careless mistakes.

Document Preparation

Next, it’s important to develop the materials used to communicate information to potential buyers. The first task is to create a “teaser,” which is used to stir up interest in the deal without disclosing either the company’s name or information that might allow potential buyers to guess the identity of the seller.
 
Next, draft a confidential information memorandum (CIM); this will be revised numerous times before it’s distributed. This document describes the company’s:

  • Products,
  • Markets,
  • Customers,
  • Competitors,
  • Industry, and
  • Historical financial information and projections.

The CIM must effectively communicate the marketing themes of the deal. The first few pages of the memorandum, composed of the executive summary and the key investment considerations, provide an opportunity to communicate what is special about the company and why it would make a great acquisition.
 
The work of constructing a data room begins at this early stage. A data room is a collection of documents that contains more detailed information than what is included in the CIM. Such documents include audit reports, employee information, contracts and environmental studies. Honest and accurate disclosure should be the guiding rule in assembling the data room — holding back negative information will result in lower values before closing and legal issues afterwards. Initially, only the CIM is available in the data room and access to other documents is provided as the deal progresses. The data room is an excellent tool for tracking interest in the deal as an audit trail is created, which provides data on which documents buyers are looking at and how often.

Marketing and Auction

Prior to distributing the memorandum, a significant amount of research is applied to developing the target list of potential buyers. Who are the logical buyers? Who has been making acquisitions in the industry? Which private equity groups are looking for deals of this size in this industry? Investment bankers maintain and subscribe to comprehensive databases used to help ensure the deal is shown to the right buyers and that no stone is left unturned in the process.
 
Once the documents and the target list are complete and accurate, marketing can begin. It starts with a phone call to potential buyers or a broader distribution of the teaser. After a confidentiality agreement (or nondisclosure agreement - NDA) is negotiated and signed, the memorandum is then distributed via data room access. A tracking list of targets is used to communicate information on the marketing process to other team members. This report typically contains contact information, milestones (such as NDA sent or data room access granted), and includes notes on discussions requiring communication to the client or other team members.
 
As the process of book distribution continues, the number of parties on the tracking list grows as the investment banker uses his or her network to expand the target list of acquirers. A skilled banker will add value to the process by finding potential acquirers that might not have seemed intuitive to others, or by pitching the deal to other potential buyers as an idea they might not have otherwise considered.
 
Once the memorandum is distributed to the list of potential buyers, they begin evaluating the deal. Follow-up questions and discussions between the banker and the buyers lead up to a target date when potential buyers are asked to submit a letter called an indication of interest (IOI), a non-binding document that identifies a value, or range of values, the buyer proposes paying for the company. Other elements of the letter may include deal structures and offer an opportunity for the buyer to make a case for considering them in pursuing the acquisition.


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The client and the M&A team sift through these letters to determine which potential buyers are chosen to advance to the next stage. This is the point when the market value of the company begins to crystallize. Clues as to how the market assigns values to different aspects of the deal and where there are weaknesses in the company’s value thesis become apparent at this stage.
 
The process of marketing a company is analogous to a funnel. If the target list begins with 100 potential buyers, perhaps 60 receive a book. If 10 submit indications of interest, perhaps only five are chosen to meet management and conduct additional due diligence in the data room.
 
Once a smaller group is chosen, a management presentation provides buyers with the opportunity to assess the management team, discuss strategic issues and tour the facilities. Often the buyers will bring their bankers. The goal at this stage is to move the buyers’ range of valuations even further above those originally submitted.
 
Just as buyers can perceive more value than they assumed when they submitted indications of interest, there are things that can push valuations in the opposite direction. Such developments include earnings deterioration, inaccurate or unfavorable information that was not properly disclosed, or a stale management presentation.
 
Once the presentations are finished and the data room has been fully updated, the next task is to choose the best buyer. Potential acquirers are given a couple weeks to refine their value calculations and line up their financing sources. The investment banker then asks the bidders to submit their final offers. These offers are structured as a letter of intent (LOI) that addresses how much they propose paying, the structure of the payment (cash, seller note, earnouts, etc.), conditions of closing and timing. The letters, although non-binding for the most part, provide the basis for choosing the final bidder. Often the bidders are provided with a draft purchase agreement that they are asked to “mark up.” This can often provide the attorney on the deal team with a sense for the key legal issues that the buyer has identified. Choosing the final buyer based solely on value without considering legal structures is a mistake many sellers come to regret later.
 
If all has gone well and there is a sense of excitement among the bidders, this is when the clout of the seller is at its peak. Although many negotiations lie ahead in the process, the time immediately before final bids are submitted is when an auction process lets the best buyer come to the forefront.

Negotiations and Closing

At this point the deal is progressing to the closing process. Once the buyer is chosen, the push and pull of the final negotiations begins. The LOI is signed and final negotiations and due diligence commence. This is the stage when the investment banker moves to the background, passing the lead role of process manager to the deal attorney. Following execution of the final purchase agreement, ownership changes hands and funds are transferred.

Takeaways

It is critical to construct a carefully managed and organized process, one that is designed to reap the benefits of the competitive auction and maximize the value shareholders realize through the sale. The company may have tremendous perceived value in the marketplace, but if the sale process is not well thought out, that value will not be realized. Worse yet, the business could suffer if, for example, trade secrets make their way to competitors or if employees, frightened by the prospects of a sale, choose to seek employment elsewhere.
 
Selling a company using a hit and miss approach without a road map and a professional deal team will rarely result in the realization of the potential value of a company in the marketplace. A well-executed process that unlocks a company’s value should be comprehensive so that once the deal is completed the seller can rest assured that all potential buyers were involved. Careful execution of these elements remains the best way to find the best buyer and cultivate the best deal.
 
Please contact Jim Lisy at jlisy@cohenconsulting.com for further discussion.
 
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.