M&A Deals - Failed Acquisitions

Many acquisitions look compelling at the time they are announced. The strategic rationale is clear, the financial model supports the transaction, and both buyer and seller have reason to believe the combination will create value.

Yet some M&A deals fail to deliver the expected result.

In lower middle-market and middle-market transactions, failure is often not the result of a single mistake. It is more commonly the result of assumptions that were too optimistic, diligence that did not go deep enough, transition risks that were underestimated, or management and cultural issues that became more difficult after closing.

After the closing of an M&A deal, it is up to the buyer to ensure the success of the transaction. However, not all of the work comes after closing. In fact, the most successful buyers expend significant time and effort before closing to understand the business, assess the risks, and develop a realistic plan for ownership.

Overestimating Synergies

When the buyer is overly optimistic about possible synergies with the target company and potential economies of scale, it can lead to disappointment after closing. Buyers may expect cost savings, cross-selling opportunities, revenue growth, purchasing efficiencies, or broader market access. Those opportunities may be real, but they must be tested carefully.

If the newly acquired company’s products or services do not grow as anticipated, or if customers do not respond as expected, the acquisition can fall short of its intended objectives. Similarly, if the buyer has underestimated the strength of market competition, the amount of capital needed to grow the business, or other costs related to the transition of ownership, it can be difficult to achieve the expected result.

Overestimating cost savings can create similar problems. Savings that appear straightforward in a financial model may be harder to realize in practice. Reductions in staffing, facilities, systems, vendors, or administrative costs can affect morale, customer service, or operational continuity. In a middle-market acquisition, the margin for error is often narrower than expected.

Underestimating the Transition

If the buyer is unable to properly manage the business, the likelihood of a failed acquisition increases significantly. The management team needs to have a strong understanding of the business being acquired, including its customers, employees, competitive position, operating processes, and working capital requirements.

The acquiring company also needs to make sure that it retains key management and other employees to ensure that operations run as planned. This is particularly important when the acquired company has long-standing customer relationships, specialized technical knowledge, or informal operating practices that are not fully captured in written procedures.

A buyer may acquire the assets, customer list, contracts, and financial history of a company. But if key people leave, customer relationships weaken, or operational knowledge is lost, the value of the acquisition can deteriorate quickly.

Transition planning should therefore begin before closing. Buyers should evaluate which employees are essential, how customer communication will be handled, what role the seller will play after closing, and whether the buyer has the internal resources to manage the company effectively.

Cultural and Management Issues

If the corporate cultures of the acquiring and acquired companies are vastly different, it can lead to poor chemistry between the employees of the two companies. This tension can deteriorate team effort, slow decision-making, and cause financial losses.

Culture is not always discussed with the same discipline as valuation, financing, or legal terms, but it can have a meaningful effect on whether an acquisition succeeds. A buyer with a highly structured corporate environment may have difficulty integrating a more entrepreneurial, founder-led company. Conversely, a decentralized buyer may underestimate the guidance and support that the acquired company needs after closing.

For sellers, this issue matters as well. Many owners care about more than price. They want to know that employees will be treated fairly, customers will continue to be served well, and the business they built will be positioned for long-term success. If part of the purchase price is tied to an earnout, seller note, rollover equity, or continued employment arrangement, the buyer’s ability to manage the company after closing becomes even more important.

The Role of Due Diligence

In order to complete a successful acquisition, thorough due diligence is an absolute must. Such diligence should include a complete assessment of the buyer’s own strengths and weaknesses, as well as a detailed analysis of the expected financial results.

Buyers should examine the target company’s financial performance, customer concentration, management depth, employee retention risk, competitive position, legal obligations, tax matters, working capital needs, and capital expenditure requirements. They should also consider whether their assumptions about synergies, growth, and integration are realistic.

Due diligence is not simply a process of confirming that the numbers are accurate. It is also a process of understanding how the business creates value, where that value may be vulnerable, and what must be done after closing to preserve and grow it.

While there are too many conflicts of interest to have an investment banker complete the buyer’s due diligence, experienced M&A advisors are well equipped to help guide the process. A well experienced investment banker knows the potential pitfalls related to doing an acquisition and can help buyers and sellers anticipate issues that may affect value, structure, timing, or certainty of closing.

Why Sellers Should Care

Although failed acquisitions are often discussed from the buyer’s perspective, sellers also have an interest in whether a transaction is likely to succeed. A buyer that has not done proper diligence may attempt to renegotiate terms, delay closing, request more seller financing, or create greater uncertainty during the process.

Sellers should therefore consider not only the headline purchase price, but also the buyer’s financial capacity, industry experience, integration plan, treatment of employees, and ability to close. The highest offer is not always the best offer if the buyer cannot complete the transaction or manage the business effectively after closing.

In many middle-market transactions, the seller remains involved for a period of time after closing. The quality of the buyer, the clarity of the transition plan, and the alignment between buyer and seller can have a direct effect on the outcome.

Reducing the Risk of Failure

M&A deals can be exhilarating for both the buyer and the seller, if done properly. But enthusiasm alone is not enough. A successful acquisition requires disciplined analysis, realistic assumptions, thoughtful diligence, strong communication, and a clear plan for the transition after closing.

The most successful buyers do not wait until after closing to think about integration, management, culture, or capital needs. They evaluate those issues before closing and structure the transaction accordingly.

For sellers, preparation is equally important. A company that is well prepared for diligence, supported by a strong management team, and able to present a clear growth story is more likely to attract qualified buyers and complete a successful transaction.

Versailles Group advises lower middle-market and middle-market clients on mergers, acquisitions, divestitures, private placements, and related transaction matters. If you are considering an acquisition, preparing to sell a business, or evaluating the risks associated with a potential transaction, please contact Versailles Group for a confidential consultation.

M&A Deals - Locked Box

Locked Box

In M&A deals, buyers and sellers are always looking for ways to reduce what is often a lengthy process of preparing, reviewing, and agreeing on final price adjustments derived from the closing accounts. In order to simplify this process, more M&A transactions are beginning to implement a “locked box” pricing mechanism. The locked box mechanism negates the need for preparing and reviewing final price adjustments post-closing and allows the buyer and seller to allocate their resources into other aspects of the M&A deal.

The Locked Box M&A deal is an essentially a fixed price transaction. This means that the equity price is fixed in the sale and purchase agreement at signing based on the historical balance sheet at the pre-signing date or “locked box date.” Protection against any “leakage” of value between the locked box date and the closing is provided by the seller through representations and warranties written into the sale and purchase agreement and are usually supported by indemnification. This “leakage” of value can be in the form of dividends, management fees, or the transfer of assets. By using this mechanism, no closing accounts are required. Therefore, there are no adjustments made between the locked box date and closing; the price the buyer is paying is the price agreed upon at the locked box date.

There are several benefits from both the buyer and seller’s point of view with regard to the locked box. It offers price certainty as the price is fixed from the locked box date which makes the deal simpler as there is no closing mechanism. There are fewer costs associated with this deal structure as the creation of a definitive agreement takes a shorter amount of time. Another benefit is that management’s time is not tied up post-closing. Provided the seller can offer appropriate comfort in terms of the integrity of the locked box balance sheet as well as relevant warranties over locked box accounts, the locked box will be beneficial for both parties.

As in all M&A deals an experienced M&A firm can help take care of these details. Many think that their lawyer can handle these points, and they’re right. But, the most successful transactions are completed by a team and the most successful entrepreneurs and corporate managers know this. When the team addresses these types of complex issues, the client always wins!

M&A Deals Telecom

M&A Deals - Telecom Industry - Q1 Update

M&A deals in the telecom space are off to a good start this year. Through March 23, 2015, there have been 90 M&A deals - telecom closed or announced worldwide. With approximately one more week left in the quarter, this is more transactions than either Q1 2013 or Q1 2014.

Here’s a chart showing the activity by quarter from 2013 to date.

With regard to value, through March 23, 2015, US$663.2 billion of M&A deals were closed.

Europe saw the most M&A deals with 43 of the 90 transactions. Asia was next with 19 transactions. Here is a chart with the number of transactions by region.

M&A Deals

Healthcare M&A Deals

Healthcare M&A deals are off to an excellent start this year as evidenced by the chart below, which shows the increase in value of M&A deals from January 1 to March 19 of this year as compared to the same period last year.

This strong M&A activity continues a trend of increasing transaction values in the Healthcare sector. Since 2012, the aggregate value of healthcare M&A deals has grown 157 percent.

In terms of revenue multiples, and M&A deals, the following segments had the highest multiples:

In terms of EBITDA multiples and M&A deals, the following segments had the highest multiples:

Most people watching healthcare M&A deals in 2015 believe that it will be a very strong year in terms of numbers of transactions and the value of such transactions. The Affordable Care Act is pushing companies to get larger and larger to achieve economies of scale in order to compete effectively. From our vantage point, it appears that healthcare companies need to get larger or they won’t be able to compete in today’s more demanding marketplace.

For companies on the acquisition “trail,” it’s imperative to have an experienced M&A advisor on the team to help refine the acquisition criteria so that important transactions are not missed. With clear criteria, targets can be identified and contacted quickly to make the process as efficient as possible. Furthermore, if a number of targets are contacted at once, the buyer gains valuable strategic market information, can complete comparison “shopping,” and conclude the best possible M&A deal.

For healthcare companies interested in selling, it’s important to have an M&A advisor that can properly identify, worldwide, every possible buyer in order to create the best possible auction. An experienced Investment Bank should be able to create a worldwide, silent auction in order to make sure that a proper market is made for the seller. The second and third bidders will also keep the “winner” honest during the due diligence phase. Furthermore, should the “winner” not be able to complete the transaction, for any reason, the second and third place bidders should be considered as excellent back up buyers.

Cross-Border M&A

The world is getting smaller, at least from an M&A perspective! Increased competition and globalization in almost all industries have fostered an era of friendly M&A deals without borders. Strategic buyers have been the primary source of M&A transactions in recent years as many firms look to remain competitive in an increasingly global landscape. Most of the time, M&A deals are completed for either offensive or defensive reasons. And, post-recession, the companies with cash have wanted to deploy it quickly and efficiently. Most of the time, the best way for a company to invest is by buying another company. In the “old” days, a company would create a strategy and business plan to expand its business. This would include acquiring or building new plants and equipment. In today’s environment, that takes too long and is too risky for most companies. Therefore, buying another business is a faster, more direct, and less risky approach to expanding a business.

As technology continues to make communication throughout the world easier, companies have not hesitated to do transactions in other countries and continents. These cross-border deals have further fueled M&A in recent years. Acquisitions provide the buying company with an opportunity to expand its global reach in order to generate new sources of revenue, acquire new technology or products, etc.

It is important to note that, unlike the M&A deals of the 1980’s, the transactions taking place today are much more friendly in nature as strategic buyers look for target firms that can complement their core competencies.

The role of investment banks in M&A transactions has also evolved with the motivation of buyers and sellers. Today, more than ever, investment banks are required to be global in their reach. Investment banks that fail to offer cross-border services are proving to be less valuable to strategic buyers who are looking to expand their businesses across the globe. It’s imperative to work with a firm with many years of cross-border M&A experience, as there are many nuances and cultural factors that play into closing a successful transaction. This is true whether it’s hiring an investment bank on the buy side or the sell side.

M&A Deals

Activist Investors and M&A

M&A deal making, over the years, has been affected by activist investors. This is particularly true for financial sponsor buyers such as private equity firms. In most cases, financial sponsors are more sensitive to changes in the valuation for a target company as compared to strategic buyers. There are two primary reasons for this. First, the shorter investment horizon for financial buyers makes it difficult for a financial buyer to add enough value and to sell out with a gain within three to five years. Strategic buyers, on the other hand, are usually making acquisitions for the long haul, which means they don’t have to face that issue. Second, strategic buyers are able to achieve economies of scale on many fronts, which means they can afford to pay more, up-front, for the target.

Activist investors have deterred some financial sponsors or private equity firms from completing M&A deals by bidding up share prices of target companies that the activist investors view as too low. Run ups in the share price of potential target companies makes acquisitions too costly for some financial sponsors, thus discouraging M&A transactions. While strategic buyers have proven to be more flexible in purchase price, they too are finding it harder to complete deals where activist investor presence is strong. The activist investors’ demand for a higher purchase price has made obtaining shareholder approval to complete an M&A transaction more challenging.
The key to getting M&A deals done amidst strong shareholder activism is through detailed target selection and management’s need to pitch the deal to their shareholders from inception. These are not easy tasks and having an experienced financial advisor to guide the management team through the M&A deal is invaluable. An investment bank with decades of experience will be better suited to help management successfully complete an M&A transaction even in the presence of strong shareholder activism or other challenges.

Mortgage-Backed Securities

A mortgage-backed security, or MBS, is an asset-backed investment that is secured by one or more mortgages. This type of financing is rarely used to complete M&A deals; however, it’s an interesting investment. Occasionally, we like to inform our readers of interesting financial instruments or other matters of interest.

Investing in an MBS is similar to lending money to a homebuyer taking on a mortgage. However, instead of receiving a mortgage that is financed solely by the bank, the mortgage is funded by an open market of investors. Investors reap a return on their investment via the interest rate associated with monthly payments on the mortgage. Because of this functionality, it is clear why an MBS can also be referred to as a “mortgage pass-through.” Mortgage-backed securities generally achieve a rate of return that is slightly better than government treasury bills or high-grade corporate debt.

The greatest risk to investing in an MBS is known as “prepayment risk,” or the chance that the mortgage is repaid ahead of time. Prepayments of mortgages are most likely to happen in a low-interest-rate environment or when interest rates are declining, as homeowners refinance their mortgages at a lower interest rate. The acceleration of prepayments creates a “reinvestment risk” for the investor who must reinvest the principal that has been prepaid in a now lower interest rate environment. Due to the reduction of interest rates, it is difficult for the investor to reinvest the principal at a rate comparable to the original rate of the original MBS investment.

The opposite of prepayment risk is “extension risk.” This is the risk that the mortgage repayment takes longer than expected. This scenario is most common in a rising interest rate environment as homeowners are less likely to make the required principal payments on their mortgages. This, in effect, extends the life of a low-yielding investment in an environment where interest rates are increasing.

Founded in 1987, Versailles Group is a boutique investment bank that specializes in international mergers, acquisitions, and divestitures. Versailles Group’s skill, flexibility, and experience have enabled it to successfully close M&A transactions for companies in the middle and lower-middle market. Versailles Group has closed transactions in all economic environments, literally around the world.

Versailles Group provides clients with both buy-side and sell-side M&A services and has been completing cross-border transactions since its founding in 1987.

M&A Deals

Acquisitions

There are several reasons why companies make, or should consider making, acquisitions. Among the more important reasons are the following:

Accelerate market access for existing products. For example, for a non-US company, the US and Canada combined would provide exposure to one of the largest and most vibrant markets in the world.

Obtain skills or technology faster or at lower cost than they can be developed.

Acquire products in other geographies that can be manufactured and sold in the company's home territory.

Increase market share and/or reduce competition.

Diversify product portfolios or add entirely new products.

Achieve economies of scale for production, sales, etc.

Develop cross-selling opportunities.

Enable vertical integration.

M&A deals require focus and attention to detail. A well-experienced investment banker can help a company refine its objectives with regard to an acquisition and help them complete a successful transaction.

Over the years, many prospective clients have come to us with an idea that they'd like to acquire another company. In many cases, the idea hasn't been a bad one, but not worth pursuing. Some CEOs believe that an acquisition will fix an unprofitable or troubled business. Yes, that's possible, but not likely. In other words, one should consider acquisitions carefully, define the goals of acquiring a company, and then devise a strategy and tactics to achieve it. Buying something for the sake of it, will not increase shareholder value. And, certainly buying a company without carefully defined objectives will only exacerbate profitability or other problems at the acquiring company.

M&A Deals

Confidential Information Memorandum

A Confidential Information Memorandum (“CIM”) (also known as an Offering Memorandum) is used as the primary marketing tool for the selling company in an M&A transaction. It is a written and detailed description of the company that is for sale. Frequently, the CIM is greater than fifty pages long and contains information about the company’s products or services, markets, technology, manufacturing, sales and marketing efforts, staffing, financial information, etc.

The selling company’s management team along with an experienced team of M&A advisors will work together to develop an accurate and comprehensive CIM that details the most important features about the company for sale. Typically, a significant amount of time is spent preparing the CIM before it is deemed to be complete and ready for distribution to interested buyers, who will have executed non-disclosure agreements in order to receive the information.

The objective of the CIM is to give potential buyers a strong understanding of the company for sale. Sometimes modified versions of a CIM are created which will be presented to strategic buyers in instances where the seller may be concerned about sharing specific confidential information with a competitor.

The financial information provided in the CIM is one of the most important sections. It always includes both historical and projected financials, which help prospective buyers determine an initial valuation for the company. The projections that are created need to be defensible and there should be a clear explanation as to how the selling company plans on reaching those goals. Potential buyers will look closely at these numbers as they are a major factor in their determination of an initial valuation of the company.

M&A Deals - Entrepreneurs

Versailles Group is pleased to announce the publication of its newest Ebook - Five Common Fears That Entrepreneurs Have When Selling Their Business." This Ebook is designed to help entrepreneurs complete M&A deals, in particular, the sale of their company.

Entrepreneurs, after spending a lot of time and effort to build a company, always have many uncertainties regarding the possible sale of their "baby." This eBook addresses several points including:

How value concerns can be mitigated with deal structure

Buyer motivation

What happens to employees and customers after a sale

What happens to employees and customers after a sale

How confidential information is kept safe throughout the sales process