This newsletter summarizes the main steps involved in acquiring a business as part of a structured process, from initial preparations to post-closing adjustments.
We also explain the investment banker’s role as a quarterback throughout the process to ensure a successful transaction.
Preparation to Approaching the Market
Definition of the objectives and the ideal acquisition profile
The very first step in acquiring a business is to identify the objectives. Several questions are generally asked of the client to better determine which acquisition profile best satisfies the objectives.
- What are the strategic objectives? Penetrate new markets? Sell a new product line? Vertically integrate with a supplier or customer?
- What is the target region? Do you have the financial and management resources to undertake a geographic diversification?
- What is your financial capacity? What size of business can you afford? Do you have the resources to capitalize on a smaller target acquisition strategy to consolidate a market?
First, the investment banker will work with you to quantify the size of the targets you should aim for by analyzing your balance sheet, debt capacity, and the need for a financial partner (with accompanying impact on the dilution of your equity).
Preparing the Ground for a Transaction
Before launching the process, you will need to assemble your transaction team which will consist of internal and external players. Internally, you will have to appoint a project leader and provide them with the necessary internal resources related to the preliminary analysis, due diligence, and eventual integration of the target. Experience tells us that transparency and involvement with your own employees reduces the insecurity of continued job security and promotes team building and a sense of belonging.
Externally, in addition to signing on an investment banker, you should also bring your legal counsel, tax specialist and accountant on board. If you lack any of these key players, or if they are unavailable (i.e. due to conflicts of interest), we highly recommend hiring such professionals with M&A experience. Some preparatory work by your accountants and lawyers, such as tax planning or corporate record updating may be required in order to ensure there are no last-minute snags on your side of the process.
We also recommend informing your financial partners about your plans early on. You will want them to be ready when the opportunity arises and they might also keep an eye out if they see an opportunity arises that fits your strategy.
Comprehensive Research of Potential Targets
There are several approaches to finding the ideal target. Some investment bankers favour the approach of “spreading” your acquisition approach across their network. In our opinion, the network approach is insufficient as it will typically only reveal companies that are already on the market. All too often, companies “on the market”, have been so for a long time and sophisticated buyers have already passed on them.
More often than not, we find that the best opportunities are those that are not yet for sale. It is important to be proactive and solicit them directly.
In order to find qualifying potential targets, Cafa creates a list of potential companies according to your originally predefined objectives. The list is generated through existing industry knowledge and targeted and exhaustive research largely done through our various proprietary databases and in-house tools.
For further reading, please consult our Finding the Right Company to Buy newsletter.
Approaching the Market
In order to maximize success, your investment banker must be experienced, resourceful and persistent. He will exploit his network of contacts to facilitate introductions and use a number of methods to find the right contact information. The preferred approach will always be to contact the ultimate stakeholders (typically the shareholders) rather than an executive who may not own a stake in the company.
The initial approach should be by way of an emailed one- or two-page “teaser” explaining the “who” and “why” of the acquisition. This teaser must show a certain transparency to make the approach credible and solicit interest. A subsequent telephone contact will follow up on the email to ensure it was seen, to further explain the intentions, to gauge the interest in pursuing a process and then set up an initial exchange, possibly with both the buyer and the seller to explore the possibility of a transaction.
Should there be sufficient interest, the parties would next sign a nondisclosure agreement for the exchange of financial and commercial information. Such information should include: financial statements for the last few years, internal results and balance sheets for the current year, projections for the coming year, some basic information on clients and suppliers, product lines, production data and capabilities, market information, summary corporate and HR structures, business plans, etc. Some proprietary information, such as client and supplier names, may be withheld until the very end of the acquisition process for competitive reasons. In other cases, legislation may prevent divulging information such as employee personal information. Note, however, that none of this missing information prevents a reasonably accurate evaluation of the target.
Evaluation, negotiation and drafting of the letter of intent (LOI)
A typical LOI covers the basic components of a transaction such as price, payment terms, closing conditions, etc. It will also establish a timeline during which the buyer can conduct its due diligence and negotiate a purchase agreement during a period of exclusivity.
In terms of valuation, the investment banker will perform a preliminary valuation of the company, typically based on public company comparables and like transactions. The work will also include quantifying potential synergies. Based on the valuation exercise, a value range and a negotiation strategy will be recommended to reach an agreement, all subject to a satisfactory full due diligence. For more information on the valuation of a business, please consult our newsletter The EBITDA Multiple and Enterprise Value.
In addition to the valuation, the LOI should include a method of calculating the working capital to be delivered at closing. Depending on the context, the precise amount of target working capital is sometimes calculated and negotiated at the LOI stage. At other times it will be calculated during due diligence using a calculation method negotiated in the LOI; for example, the monthly average of the last twelve months. Please read our newsletter on Minimum Working Capital Threshold in M&A Transactions to learn more.
The investment banker will also need to ensure that the LOI is comprehensive enough to minimize negotiation points at the purchase agreement stage. It is therefore good practice to include the basis of the representations and warranties and their duration, the indemnities, the basis of the employment and/or non-competition agreement with the sellers and the various closing conditions (working capital adjustments, representations and warranties, performance clause).
It should be noted that the LOI will be subject to the results of due diligence and the buyer will have the opportunity to not proceed with the transaction, acting in good faith, if the findings of its analysis revealed material issues. Your counsel should also review the LOI before it is issued as it will also be used in the eventual drafting of the purchase agreement.
For more information on the LOI, please refer to our newsletter Indications of Interest, Letters of Intent, Sale/Purchase Agreements.
The development of the financing strategy by the investment banker begins with the analysis and the drafting of the LOI to ensure that the transaction does not stall or fail at the financing stage. The investment banker should prepare a proper financing package on a timely basis which includes:
- A confidential information memorandum (CIM) on the target, the transaction, the buyer and the merits of the acquisition,
- a financial model with detailed projections and assumptions and pro forma financial ratios,
- the executed LOI,
- if available, valuation reports on tangible assets (equipment, real estate, etc.) and possibly the various due diligence reports produced, and
- a cover letter that clearly explains the financial structure sought and the form of financing requested.
Having a complete financing package will greatly accelerate the speed at which the buyer obtains transaction outlines and maximize the chances of meeting the closing deadlines.
The investment banker will directly solicit his network of traditional and alternative lenders and will accompany the acquirer through the various stages of raising financing (obtaining financing outlines, followed by the letters of intent and, finally, credit agreements).
In the event the required financing exceeds acceptable leverage, the investment banker may also solicit majority or minority equity partners as may be required.
Due diligence will commence immediately following the execution of the LOI. The investment banker will coordinate the due diligence and work closely with the company and its advisors (legal, accounting, tax, etc.) to ensure that all matters are covered and that the buyer meets the timelines set out in the LOI (typically 30 to 60 days).
The due diligence will typically include a review of all material information, including accounting, tax, legal, environmental, human relations and operations. Note that where financing is required, the lender (or investor) may require access to the due diligence material and conclusions. Please see our Due Diligence tool for more details.
Another important aspect often overlooked in a business acquisition is customer due diligence. A company’s customers are one of the most important assets of a target. Please see our Customer Due Diligence newsletter.
While it is sometimes natural for a buyer to turn to their long-time professionals, our experience has shown us the importance of assembling a team of M&A-savvy professionals for due diligence. Many mid-size to large accounting and legal firms have experienced teams dedicated to these exercises.
It is also during the due diligence process that the buyer can seek insurance for representations and warranties. This insurance product will cover recourse against the seller for a breach of representations and warranties for a problem that was not raised during the due diligence exercise. This type of insurance policy is used to reduce friction between the buyer and seller if the seller remains in place after closing or for private equity funds. It minimizes friction between the parties in the event of a claim, as the buyer will have to go directly to the insurer rather than the seller. It is good practice to announce your intentions to have this type of insurance in the LOI. For more information, please see our newsletter on Representations and Warranties Insurance – M&A transactions.
If the due diligence does not raise any major issues that could jeopardize the transaction, both parties will prepare for the closing of the transaction on the agreed upon date. Legal counsel, preferably the buyer’s, will prepare the purchase agreement, based on the commercial terms agreed upon in the LOI. The terms may be subject to change based on new information discovered during the due diligence process.
At this stage, Cafa’s role will be to ensure that any final points of negotiation are ironed out and that the legal agreement reflects the “spirit of the transaction”.
As a final note, if the vendors do not use an investment banker or other M&A professional advisor on their side, you can expect a more difficult transaction.
We believe the above covers the main steps involved in acquiring a business. Nonetheless, we invite you to read our Day 1 and Post-merger Integration papers and Post-merger Integration – Reaping the Benefits of Your Acquisition newsletter to learn more about the steps to a successful integration.
Cafa will be pleased to assist you as your investment banker in your acquisition project by maximizing your chances of success while building momentum and putting in place an appropriate financing structure.
main steps involved in acquiring a business
main steps involved in acquiring a business
main steps involved in acquiring a business