Health Enterprise M+A

Let’s continue our stroll through the Dealmakers’ Neighborhood and meet our friendly neighborhood investment banker.

The investment banker fills a critical role in most middle-market deals by organizing the transaction process, developing the go-to-market strategy, getting the right potential buyers at the table, facilitating due diligence and then shepherding the deal to a successful close. While some business owners are hesitant to hire an investment banker, I find that’s most often a product of not having a full understanding of the banker’s role and the value the banker can provide. I’ve often found that the best bankers more than pay for themselves by running a process that is designed to maximize transaction value, secure the most favorable terms and ensure a successful closing. Most business owners will sell their business only once; it’s worth doing it right.

This month, we’re delighted to welcome Andy Male from Citizens Capital Markets, a seasoned deal-making veteran and loyal Anatomy of a Deal reader, to share his perspective on the investment banker’s role in the M+A world.

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Every year, the end of September presents us with a compelling trade: the reluctant last days of summer in exchange for the exciting first days of the NFL season. Football fans are always happy to make that deal. September also marks the end of the third fiscal quarter and the beginning of the strategic planning season for business owners. For many, these planning sessions include evaluating M+A as a strategic alternative for the first time, particularly given record valuations and the pending risk of higher capital gains tax rates. M+A can be a daunting topic to assess for the uninitiated, replete with questions about how a process works, how to prepare for a process and what role investment bankers play in the process.

Fortunately, there are parallels between M+A and the NFL as outlined below, that business owners can look to for instructive reminders as to how the game of investment banking is played and won. Clock management (aka, market timing) is among the most critical and our predictions for the 2021-2022 M+A season are optimistic. Just as NFL fans are returning to stadiums this fall, so are M+A buyers and sellers returning to the capital markets. M+A activity has returned to record levels, and private business owners are again inundated with calls from prospective buyers.

If you choose to explore these discussions, keep the following insights and best practices in mind as you design and execute your game plan.

Mergers + Acquisitions: Rules of the Game

M+A is a dynamic game played on a crowded field between buyer and seller, each supported by a cadre of advisors driven to secure victory for their respective stakeholders. The score is kept in terms of Enterprise Value (EV) and is most often expressed as a multiple of EBITDA (EV divided by EBITDA).

The game's incentives are clear to both parties: sellers want to maximize value, buyers want to minimize risk, and the negotiation process is designed to produce a point of equilibrium between the two. In lower-middle-market M+A (where EVs are less than $500 million), the game is often played between veteran professional buyers and rookie sellers, which can make for lopsided competition (e.g., public company corporate development teams and private equity investors versus multi-generational family business members).

As such, sellers need to engage a team of professional advisors to level the playing field. Among the first of these hires is the investment banker, whose job is to design and execute the transaction process. Investment bankers tailor the game plan to meet their clients’ objectives, namely maximizing enterprise value, obtaining favorable transaction terms, strengthening certainty of close and ensuring cultural fit. Relative to the NFL, think about M+A as being played over four “quarters”: training camp, offense, defense and special teams.

Training Camp: Market Preparation

“TTM EBITDA! Revenue Bridge! R+W, TAM! TAM! TAM! Hut!” When these plays are called throughout the M+A process, your team needs to execute each flawlessly under pressure to win the game. Like in the NFL, however, the game does not start on day one of the process. First, you need to get into shape, learn the playbook and build team chemistry. Welcome to training camp! For the rookies, expect the following:

• Getting into Shape: Kick-Off Meetings and Quality of Earnings. The process begins with a kick-off meeting hosted by the investment banker and entails a thorough review of the company’s strategic plan. We meet with the CEO, CFO and other executives to assess the company’s historical performance and growth opportunities. Drills we run include SWOT analysis, customer concentration and bottoms-up projection model building. Most transactions include a sell-side quality of earnings (QofE) report, which is conducted by an independent accounting firm. These reports inform the financials that investment bankers use to market the business and are critical for uncovering and addressing potential issues before the game begins. Like in the NFL, we run these drills again, again and again before going to market and our preparation pays off in the form of excellent execution when addressing challenging buyer questions.
• Designing the Playbook: Confidential Information Presentation (CIP). The key selling document of the marketing process is the CIP, which the investment banker drafts in coordination with the company’s management team. CIPs clearly and convincingly convey the company’s investment highlights to buyers. Popular investment highlights include an unmatched value proposition, a defensible market position, an attractive financial profile with recurring revenue and consistent margins, a veteran leadership team and, most importantly, compelling growth opportunities. Like with NFL playbooks, the CIP is highly confidential, and we protect access to it using confidentiality agreements.
• Meeting the Team: Roles, Responsibilities and Chemistry. In this analogy, the investment bankers are the coaching staff, led by a managing director as head coach and experienced bankers as coordinators and staff. As coaches, your investment bankers design the strategy, run drills and call the plays. At times, you’ll be frustrated with your coach for making you run wind sprints, but you know they have your best interests at heart and are obsessed with winning. The company’s CEO is the quarterback, the CFO is the running back and the sales executive is the star wide receiver. The company’s infrastructure and systems are the offensive line, critical to success. Like NFL fans, these are who the buyers come to see perform. The most direct comparison is that of the owners. Just as NFL owners hire the coach, staff and players, the company owner hires the investment banker and the management team to execute their vision. And, it’s the owner who gets handed the trophy at the end. The key to getting that trophy is excellent team chemistry. Just like a team of NFL rookies would not make the Super Bowl, neither would a team of inexperienced business leaders perform well in M+A. Veteran management teams with chemistry built on trust from years of playing together win the game. Importantly, buyers don’t want to be overly sold by the investment banker on an opportunity; they want to see and believe in the management team. As such, build and prepare your management team accordingly to win.
• Public Relations: Managing Communications. Like in the NFL, confidentiality is critical. Bankers limit information sharing to only what is necessary by stage, use code words and execute non-disclosure agreements to minimize the risk of this vital information getting into the wrong hands. Fortunately, unlike the NFL, we don’t allow cameras in training camp and there’s no “Hard Knocks” crew in the boardroom. When the season starts, like the interactions between NFL players and the press, your team will be asked the same questions again, again and again from buyers. Fortunately, you will be prepared to answer these questions like a seasoned veteran.

Congrats on completing training camp. Your team is ready to go to work. Time for kickoff!

Offense: Marketing the Businesses

The marketing process begins like all NFL season openers: full of hope, confidence and eternal optimism. Fortunately, as a seller, those feelings are warranted because you set the game schedule. One of your investment banker’s essential jobs is to advise you on appropriate market timing given industry trends, the company’s financial performance and your strategic objectives. Only when those timing dynamics are aligned and our preseason preparation is complete do we start the game. When the game begins, the seller always starts with the ball on offense, driving toward the following milestones:

• Teaser and Non-Disclosure Agreement (NDA). The first series entails the investment banker introducing the opportunity to prospective buyers using an anonymous teaser. The teaser provides enough high-level business and financial data to assess the opportunity while mitigating confidentiality risks. A segment of prospective buyers will pass based on the teaser due to their perception that the opportunity lacks a strategic “angle” for that potential buyer, investment size requirements, timing or other M+A priorities. Buyers that execute the NDA will receive the CIP and instructions for submitting an Indication of Interest.
• Indications of Interest (IOI). The second series entails the investment banker discussing the CIP content with prospective buyers. Over a series of calls, the banker drives home the selling points of the opportunity, the shareholders’ objectives, and what a winning bid may look like. The banker issues an IOI process letter, specifying instructions for submitting a letter, including a valuation range (most often expressed as a multiple of EBITDA). Buyers also outline a history of their group, rationale for bidding on the opportunity and reasons why they would be an ideal buyer. The investment banker summarizes these bids into an IOI bid grid on an “apples-to-apples” basis for the seller to review. This drive ends with the seller and banker inviting a select group of bidders to meet with the company in person, a process formally known as Management Presentations.
• Management Presentations (MP). The third series, referred to as “MPs,” includes some of the most critical plays of the game. This is the first time sellers meet prospective buyers in person. MPs often include a social element (e.g., private dinner), facility tour and formal presentations by each starting line-up. Buyers give a presentation they have done hundreds of times, providing a history of their group and outlining why they are interested in the opportunity. Next, the sellers formally present the MP, provide facility tours and make clear their transaction objectives. Buyers question the presenters to learn more about the business. Like NFL rookies in their first game, the first meeting will seem really fast, and they will not answer the questions concisely. By the final meeting, your team will have become a veteran squad, seeing defenders’ moves before they happen and answering questions with the aplomb of an All-Pro league star. These meetings often run back-to-back-to-back over a two-week time period, so your team will be tired but feeling good in their accomplishment. This drive ends with the investment banker providing each MP attendee with detailed instructions for submitting a Letter of Intent.
• Letters of Intent (LOI). Your offense’s final series, LOIs, produces the final EV scores of the first half. Buyers will be given additional data and time after their MP to submit an LOI. As opposed to an IOI, an LOI is a detailed proposal to purchase the business, including a single Enterprise Value and sources of capital for the transaction (third-party debt, investor equity, rollover equity). You can check out Kegler Brown’s other Anatomy of a Deal articles for details on these terms. The investment banker presents LOIs on an “apples-to-apples” basis to the seller for review and discussion. After several rounds of negotiation, this series culminates with the seller selecting a single party with which to enter exclusivity and work together to consummate the transaction as agreed to in the LOI.

It is vital for sellers to remember that their point of maximum leverage is just prior to signing a Letter of Intent. After entering exclusivity, leverage shifts to the buyer. Thankfully, your first half has paid off. You have “cleared the market” of prospective bidders, leveraged competition to maximize value and terms and are now in a position to close a transaction with a buyer that meets your criteria. Now, it’s time to play defense. Get a drink, take a breath and get ready to play exceptionally well in order to get this deal done as agreed to in the LOI.

Defense: Confirmatory Due Diligence

The buyer begins the second half moving the ball aggressively. Why? Because their exclusivity clock is ticking, a multi-faceted capital structure needs to be constructed, and they have started spending real money on due diligence providers to close this transaction. For the seller, there needs to be seamless coordination between the investment banker and M+A legal counsel, who acts as the seller’s defensive coordinator through the close of the transaction. Expect the following second-half plan.

• Time on the Clock: 60 Days. Letters of Intent grant buyers exclusivity for a limited time, typically sixty days, with thirty days being possible in unique circumstances. Ninety days is too long, and should only be necessary in rare circumstances, such as where specific regulatory requirements or exceptional diligence is required.
• Second-Half Adjustments: Due Diligence Reports. As is fair play in M+A, the buyer engages a team of financial and legal advisors to question everything we presented in the first half. An accounting firm will conduct a Quality of Earnings (Q of E) report. A legal team will review customer contracts, organizational documents and past/pending litigation matters. Environmental, market, and technology consultants may also be hired to study the company’s position. Each party is looking to uncover potential risks to the buyer, and any material issues discovered could reopen key business negotiation points (e.g., valuation, terms, risk-sharing). At the same time, the buyer’s counsel will be negotiating the most important document in the process, the Purchase Agreement.
• Purchase Agreements: APA, SPA, TSA, etc. The purchase agreement is the definitive transaction document. It is informed by the Letter of Intent and supersedes the LOI in terms of enforcement. If a post-transaction issue arises, lawyers will look to the purchase agreement for resolution, not the LOI. As such, it is imperative for the seller to be represented by experienced M+A counsel. Other important documents include operating agreements, a transition services agreement and employment agreements.
• Financing Sources: Banks and Equity. Unlike large corporate buyers that use cash on their balance sheet or an existing revolver to finance transactions, private equity firms rely on third-party financing. Those third-party debt providers conduct their own due diligence, which will require lender presentations. Whereas equity investors are focused on growth and upside, lenders are focused on risk mitigation (cash flow consistency, competitive trends, regulatory risks) and your team will be prepared to answer those questions accordingly.

Special Teams: Closing the Deal

Most M+A transactions come down to the wire. Both teams are battling at the line of scrimmage, engulfed in a cloud of dust. Owners, bankers, lawyers, accountants, wealth advisors and management team members, all there, pushing and waiting for the referee’s official call when the whistle blows. Unlike in the NFL, these scrums most often end in a tie with the ball at the 50-yard-line. Both sides have done great work and discovered the “willing buyer, willing seller” equilibrium.

Unique to M+A, these ties are actually wins, as closing a deal is no small feat. Deals can go awry for many reasons, so keep the following in mind as your team plays the game:

• Laces Out! Both teams need to have M+A industry veterans who know how to execute the fundamentals of a transaction under pressure. Accordingly, the importance of highly experienced M+A bankers and legal counsel cannot be overstated. Counsel is responsible for translating the banker’s LOI into a binding legal agreement and knowing how to negotiate the myriad issues that arise throughout diligence. The banker and legal teams work as one to snap, hold and kick the 55-yard game-tying field goal at the end of the game. Both parties need to have the ice-cold demeanor that only comes through deep M+A experience to do so.
• Preventing Turnovers. Like fumbles and interceptions in the NFL, re-trades (i.e., lower valuations) happen in M+A. Why? Missed projections and due diligence surprises are the leading causes. If trailing-twelve-months (TTM) EBITDA trends down post-LOI compared to the CIP projections, the buyer will reopen negotiations. The same is true if an undisclosed liability is uncovered. To prevent such surprises, have a banker run the process so that your management team stays focused on day-to-day operations and the required diligence documents are properly aggregated and disclosed. A good practice is that the management team should continue to plan for and run the business as if no transaction was going to happen.
• Flea Flickers. Creativity is essential in M+A. All deals have negotiation issues and there are rarely easy answers. Like in the NFL, the spirit of never giving up until the clock strikes zero is a key to M+A. Work to the end, exhaust all options, and constantly communicate, as you never know how one proposal may break the issue at hand and clear a way for the transaction to close.

The Offseason

Congrats on a great game! You are signing the purchase agreement and the wires will cross immediately thereafter. Where does the money go?

• M+A Math. Like a coach on a locker room chalkboard, your investment banker will walk you through how proceeds calculations work. You will understand how enterprise value, net debt, working capital targets, equity rollover, seller notes, rollovers, escrows, transaction expenses and taxes determine how much cash and other considerations you will receive at close. See Kegler Brown’s other Anatomy of a Deal articles for details on these topics.
• Contract Negotiations. How do transaction advisors get paid? Investment bankers are paid a contingent success fee that is typically calculated as a percentage of enterprise value with certain minimums and incentives that apply. These fees are paid only if a transaction closes. Lawyers and accountants typically bill hourly and by project, respectively. Buyers and sellers pay their respective fees.
• Player Incentives. The seller’s deal team often includes non-equity owners who played a critical role in the transaction. Your investment banker will advise you on appropriate transaction bonuses and other employee incentives for these employees. Eric has also written on these employee incentives before in two parts.
• Retirement? M+A transactions often create generational wealth for sellers, and as such, it is important to work with your personal wealth management team to prepare for this liquidity. If the transaction results in your retirement, it is especially important to make sure you have the appropriate tax strategies and wealth management plans in place. Your investment banker will advise you on when to bring your wealth manager into the M+A process discussions.

Keep these lessons in mind as you contemplate your company’s strategic alternatives…and as you watch your favorite team this fall. See you on the field!

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Next Month: The People in Your (Dealmakers) Neighborhood: Part 3, Meet Your Financial Advisor

Read last month’s piece: The People in Your (Dealmakers) Neighborhood: Part 1 Meet Your CPA