The People in Your (Dealmakers) Neighborhood: Part 2 Meet Your Investment Banker
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.---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
GameM+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 BusinessesThe 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 DiligenceThe 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 OffseasonCongrats 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!
Next Month: The People in Your (Dealmakers)
Neighborhood: Part 3, Meet Your Financial AdvisorRead last month’s piece: The People in Your (Dealmakers) Neighborhood: Part 1 Meet Your CPA
