Keeping Deals On Track
Four years ago, I joined the Alliance of Merger & Acquisition Advisors® (AM&AA), a trade organization bringing together investment bankers, private equity professionals, CPAs, attorneys and other corporate financial advisors for educational and networking purposes.
This past month, AM&AA held its Summer Conference in Chicago which included over 400 M&A professionals discussing various topics ranging from valuation and leverage trends to the overall state of the middle market. I was asked to lead the panel discussion: Keeping Deals On Track: good practices to keep a deal on track as well as how to anticipate, and resolve, likely hurdles between a buyer and a seller. The panelists included Rocky Pontikes (a seasoned investment banker from Mesirow Financial), Todd Lanscioni (a private equity investor from Jordan Company), Gregg Eisenberg (a deal attorney from Benesch, Friedlander, Coplan and Aronoff) and Jim McQuaid (Chairman and CEO of MetroGroup Holdings).
With such a broad topic, our panel chose to focus on best practices Pre and Post Letter of Intent (“LOI”). Additionally, our panel’s focus was to provide strategies to investment bankers representing entrepreneurially-owned companies (rather than private equity owned businesses).
On a Pre-LOI basis, the takeaways from our panel included the following:
Assemble The Right Team: A seller needs to select an investment banker who has an understanding and expertise of their particular industry. For example, a CEO/owner of a specialty packaging company will have a far higher chance of successfully selling their business if they retain an investment banker who understands the packaging industry. This firm will know the right financial and strategic buyers to approach, have a sense of purchase price multiples for these types of businesses, a knowledge of lenders interested in the industry, and will be fluent in speaking to prospective buyers about the sellers’ business. The same holds true for selecting a lawyer: a seller should engage a lawyer who understands their personal objectives, “fits” with them culturally, and has experience in mergers & acquisitions.
Encourage Sellers and Buyers to Foster Trust and Develop a Relationship: Rocky Pontikes articulated the need to ensure his clients sign a Letter of Intent with the right buyer from a valuation AND a cultural perspective. During the period where clients will be meeting with prospective buyers (a.k.a. management meetings), Rocky coordinates lunches and dinners in addition to the typical 4-6 hour management meeting. This provides for a more casual atmosphere to better understand how the prospective private buyer will interact with the owner’s as well as the buyers value-add post-transaction. In the case of a strategic buyer, this allows his clients to better understand how their company will fit into a larger enterprise post transaction.
Know The Buyers: As a matter of protocol, Rocky believes it is his job to “know” prospective buyers on his firm’s “buyer list”. Does the buyer understand his client’s industry? Does the buyer have a track record of closing deals? Does the buyer have the horsepower to raise the necessary financing? Does the buyer have a reputation for re-trading financial terms? Immediately prior to signing a Letter of Intent, he added, sellers should call the CEO’s of the private equity buyer’s portfolio companies to confirm their understanding as to how the buyers add value post-transaction.
Understand the Goals of the Owner: An investment banker must to able to clearly articulate and understand the goals of their client. Is the seller looking for the last dollar so they can retire, a partial liquidity event, generational transfer of ownership, etc. This allows the investment banker the ability to develop the best possible list of prospective buyers for their client’s business.
Know the Lending Climate: Investment bankers should have preliminary discussions with lenders before distributing a deal memorandum to potential buyers. This provides the investment banker (and their client) with first-hand knowledge of available leverage multiples to potential buyers and, in turn, a sense of valuation.
The Memorandum: Preparing a memorandum that not only markets the company, but also identifies the challenges facing the business is key to keeping a deal on track. The challenges a company faces will inevitably be exposed during a due diligence process. Therefore, it is better to include them in the memorandum in order to mitigate potential problems down the road. Key issues to include may involve customer concentration issues, unique vendor relationships, outstanding litigation, etc.
On a Post-LOI basis, the takeaways from our panel included the following:
Detailed Letters of Intent: Gregg Eisenberg discussed the importance of a detailed Letter of Intent. He recommends LOIs include everything from deal related economics (valuation, earn-out calculations, caps, baskets, escrow, sources and uses, etc.) to management’s role going forward and specific terms of their investment. Additionally, working capital calculations should be provided to all buyers pre-LOI to eliminate haggling over the numbers when it comes time to close the transaction.
Don’t Let The Grass Grow: It is essential to run a well-organized and timely process once its underway. Rocky warned the audience to be cognizant of adhering to a schedule stating, “generally only bad things happen when the process drags on.” A detailed LOI should include a week by week timetable for milestones with responsible party in order to keep the deal on track. Additionally, sellers should keep exclusive periods as short as possible (no longer than 60 days).
Two-Step Customer Due Diligence: Customer diligence is always a sticky issue for buyers and sellers so consider a two phase customer due diligence process. Phase I should be early in the process and would be a blind web-based survey providing the buyer a broad-based understanding of how the company is perceived by its customers while not raising red flags the company may soon have a new owner. Phase II would occur towards the end of the process and involve the company’s top accounts and involve the more typical phone call or face to face diligence effort where a customer would likely be advised a sale process is underway.
Reduce Financing Risks: While strategic buyers are better positioned to eliminate a financing contingency, private equity buyers will generally seek to keep financing as a condition until closing. Ways to mitigate this risk with buyers is to require lending sources to attend meetings, understand what extent these financing sources have performed diligence on the transaction, determine if these lenders have received credit committee approval for the transaction, etc.
Potential deal killers can originate from any number of parties in a transaction including buyers, sellers, lenders, vendors, customers, etc. However, following the strategies listed above can help mitigate sunk costs, time wasted, and most importantly a dead deal.
MCM Capital Partners is a Cleveland based MicroCap private equity fund investing in niche manufacturers, value added distributors and specialty service businesses. For more information on our private equity firm and investment principles, contact us today.