Operational Due Diligence

Operational Due Diligence

Due diligence is an important aspect of all M&A transactions as it is a process that allows the acquirer to truly understand what they are purchasing. Mistakes during this process can prove to be costly and can make the difference between a successful acquisition and a failed one. The most common mistakes acquirers make during this process are failing to conduct operational due diligence and utilizing inexperienced people to conduct the process in effort to save on costs.

When conducting due diligence, most buyers tend to focus their efforts on financial, legal, and Human Resource due diligence. What is all too commonly missed during this process is the operational due diligence, i.e., studying, in detail, the customers, products, services, and business pipeline of the company to be acquired.

Most of the time, acquirers in the same industry don’t focus on operational due diligence as they feel they already understand the target’s business or customers. In reality, it is extremely difficult to truly “know” a company as every business is unique and competitors within the same industry will usually attempt to conceal their operations from one another. Operational due diligence should not only consist of asking customers about their satisfaction levels with the target company, but also thoroughly examining customer contracts to fully understand the risks involved with acquiring those customers.

Another common mistake acquirers make is using inexperienced people to conduct the due diligence process in an effort to save costs in the short term. This strategy can lead to substantial losses in the future as inadequate due diligence increases the likelihood of missing important red flags. Acquirers should always utilize employees that are qualified to conduct thorough due diligence. If such employees do not have the bandwidth to conduct the process or will slow down the transaction to a great degree, then the acquirer should always consider hiring a consultant that knows the industry and has experience performing M&A due diligence. While using more senior employees and hiring outside consultants will increase the cost of the transaction, this is certainly money well spent to insure that the acquisition will be valuable to the acquirer.

It is all too easy for acquirers to feel comfortable with targets in their industry. However, acquirers cannot afford to overlook operational due diligence and must treat every acquisition as a prudent investor. It is also imperative that acquirers are not “penny wise and pound foolish” in the performance of due diligence. Utilizing experienced employees and hiring outside consultants to conduct the due diligence process may increase the cost of the acquisition, but it will insure the acquisition adds to shareholder value.

Acquirers should always ask their M&A advisor how to organize their diligence. M&A advisors cannot perform the actual diligence as they have a conflict of interest. However, most well-experienced M&A firms have seen the diligence efforts from both sides of a transaction. Consequently, they have the unique ability to help organize the efforts and to avoid common pitfalls, particularly with neglecting operational due diligence. Versailles Group, a boutique M&A firm that has over 25 years of experience helping buyers and sellers knows how to guide a client through this very important process. They have seen, first hand, how to and how not to conduct proper due diligence.

M&A Deals – Sell Side Considerations

M&A Deals – Sell Side Considerations

With regard to transactions in the middle market, when an entrepreneur begins the sales process of their company, he or she can easily become consumed by the process. This should be one of the most important sell side considerations for an entrepreneur, i.e., how not to get over involved in the process.

In order to complete a successful sale, the entrepreneur must maintain his or her focus on what’s most important, that being the business. This is why it is so critical to have a well-experienced M&A firm handle your transaction. Typically, boutique M&A firms offer middle market companies the best level of service for their transactions. They know how to mitigate the time and effort that an entrepreneur will have to make to the completion of a successful transaction.

The continued strong performance of the company plays an important role in a successful sale, which is why it’s one of the more important sell side considerations. When entrepreneurs neglect their companies during the sales process, they are putting the value of the company at risk. During the sales process for the company, potential acquirers will watch the financial performance of the company closely and will react negatively to any “slip up” in revenues. While a buyer may fully understand that this hiccup in performance was because of management’s focus on the sales process, they won’t hesitate to use this as an opportunity to negotiate a reduction in the value. The best way to avoid this scenario is to make sure that the M&A firm is managing the sales process so that the entrepreneur can stay focused on his or her business.

A knowledgeable financial advisor or boutique M&A firm will be able to tell entrepreneurs what materials potential buyers will want to see and may even populate a data room with such data. Getting this information ready in advance will reduce the stress of numerous data requests from a buyer once due diligence is in full swing.

Throughout the sales process entrepreneurs should always expect the unexpected. An experienced M&A advisor will be able to guide entrepreneurs through the M&A process, which is not always a straight line. As a buyer conducts its due diligence, unforeseen flaws are likely to be discovered. When this occurs, the most effective way to ease a potential buyer’s fears is to present a company that is continuing to perform well. This will not only keep the sales process moving, but will also preserve the value for the business by preventing a price negotiation.

Entrepreneurs selling their business can often times feel like they are performing a juggling act and it may seem as if there are too many things to keep an eye on. This is actually another one of those very important sell side considerations. An experienced boutique M&A firm can be the extra set of hands the entrepreneur needs to maintain the company’s financial performance while also executing a successful sale. With this type of teamwork, the highest value for the business will be obtained and the sales process can be completed in the most efficient manner.

At the risk of being redundant, it’s important for the entrepreneur to make sure that they are hiring a well-qualified M&A advisor with years of experience. They will know how to guide the entrepreneur through a variety of circumstances that always creep into M&A transactions, but are not fatal to completing a successful transaction. There are many sell side considerations and Versailles Group, a boutique M&A firm or investment bank would be happy to explain how to accomplish the best possible results in the sale of your company.

How Do I Sell My High Tech Business

How Do I Sell My High Tech Business

A frequent question is: How Do I Sell My High Tech Business. There are several steps that should be taken to maximize the value and obtain the best terms. These are outlined below.

Marketing the Company for Sale

Selling a high-tech business is a unique experience and special expertise is required to ensure a successful sale. High-tech businesses have many unique selling points that must be effectively highlighted to potential buyers in order to derive the best value. These unique selling points are the primary focus of the Confidential Information Memorandum (“CIM”) which is a detailed report on the company for sale. It outlines the opportunity for the prospective buyers. An effective CIM will clearly describe the company’s strengths, technological advantages, growth prospects, financial data, etc.

Preparing a Global Buyer List

When selling a high-tech business, contacting buyers across the globe is vital. Technology is always in high demand and foreign buyers may be willing to pay a premium for a high-tech business, particularly if a specific technology is not available in their home country. Given the fact that technology is continually changing, the technology portfolio of your company may be attractive to some buyers but undesirable to others. For this reason, it is essential to utilize a broad based, global list of buyers when selling your high-tech business.

Focus Buyers on Future Performance

High-tech businesses can often times have volatile historical financial performance, especially during phases of new product development and introduction. An experienced financial advisor will be able to focus buyers on your company’s future and how your technology can be utilized in tandem with a prospective buyer’s strategy. Framing the acquisition in this way will achieve a higher valuation for the business and better terms.

Maintaining Confidentiality

Confidentiality throughout the sales process is paramount. An experienced financial advisor will ensure that strict Non-Disclosure Agreements are in place before sharing non-public information with potential buyers. When selling your high-tech business, it is critical to protect your technology as it is often the key factor that distinguishes your firm from your competitors. A financial advisor will be able to control the sales process in such a fashion that enough information is revealed to prospective buyers to garner interest and derive value, but not enough to copy your firm’s technology portfolio.

An experienced financial advisor will guide you throughout the process of selling your high-tech business. By focusing prospective buyers on your company’s unique selling points and growth prospects, the valuation for your high-tech business can be significantly increased. This approach, completed by firm with years of international experience, will always answer the question: How Do I Sell My High Tech Business.

Why Conduct Due Diligence?

Why Conduct Due Diligence?

Many buyers ask, Why Conduct Due Diligence?

Due diligence is an audit of a potential M&A investment, which takes place prior to the closing of a transaction. Due diligence plays an important role in every M&A transaction. It is a discovery process that helps buyers understand the financial statements, potential synergies, cultural differences between the companies, and possible risks of a particular target.

Financial Diligence

It’s imperative for a buyer to conduct thorough due diligence on the target company’s financial records, particularly the income statement and balance sheet. A buyer needs to test the income statement to make sure that revenues are not inflated and that expenses are not understated. Similarly, the balance sheet items, or the value related to said items needs to be verified. In many cases, a buyer will test the inventory or even do a complete physical inventory to determine if it has been corrected stated on the balance sheet. In many cases, a buyer will also conduct a “quality of earnings” examination to determine if the earnings of the company match their understanding. Last, but not least, the buyer will want to make sure that they understand the cash flow of the business. This goes well beyond EBITDA!

Evaluating Potential Synergies

Synergies are the main motivators for many M&A transactions. Generating returns above and beyond what the two companies could achieve as separate entities is usually the goal of an acquirer. One of the most common pitfalls of M&A transactions is overestimating possible synergies. This results in buyers over paying for target companies and, in many cases, a failed acquisition. The due diligence process is a chance for buyers to do their “homework” on a target to see if these potential synergies can be realized. While potential synergies with a target company can be very appealing, it takes thorough due diligence to develop a roadmap to take these synergies from theory to reality.

Understanding Company Culture

Understanding a target’s company culture can be the difference between a successful acquisition and a failed one. In most cases, a company’s greatest asset is its employees as these are the people who manage the day to day operations and develop the strategies which define a company. The employees are a vital asset that is going to be acquired and a potential buyer should take the time during the due diligence phase to understand the culture. The culture in the workplace is one of the critical factors in determining the success of an acquisition. Differences in company culture are not always a negative as the two cultures can learn from one another; however, cultures that are radically different and cannot be managed properly will create a toxic work environment that destroys value. Due diligence gives the acquirer a chance to evaluate a target’s employees and will give the acquirer a better sense of whether these employees can be successfully integrated.

Discovering Potential Risks

Due diligence gives the buyer assurance that it is not assuming undue risk by acquiring a target company. Before signing a definitive agreement, every acquirer should have a full understanding of the risks that an acquisition poses. From a legal standpoint, the buyer will use due diligence to understand any potential litigation the target company could face in the future and if the acquirer could be liable for any damages resulting from that litigation. Due diligence also gives buyers insight into operational or financial risks of an acquisition. Debt covenants, supplier contacts, integration costs, possible off-balance sheet liabilities, etc. should all be thoroughly examined before committing valuable resources to purchasing a company.

Conclusion

Acquisitions are essential to almost every corporate strategy. They can be an effective way of building shareholder value and save companies time when trying to break into new geographies or product lines. Due diligence is an opportunity for acquirers to obtain a better understanding of the potential returns and risks of an acquisition. If utilized properly, due diligence can insure the completion of a successful acquisition.
While there are conflicts that prevent your M&A advisor from actually completing the due diligence, a good financial advisor should be able to advise their client on how to conduct the diligence process, what to expect from the process, and how to mitigate the risk of any negative findings by making adjustments to the Purchase and Sale Agreement. Versailles Group has over 25 years’ experience in advising both buyers and sellers in executing successful transactions.

We hope that this answers the question: Why Conduct Due Diligence?

Sell the Seller

Sell the Seller

Years ago, I coined the phrase, “Buying is Selling.” It’s important to remember that an essential element of making an acquisition is to sell the seller when attempting to complete the purchase of a company. This is particularly true when dealing with a founder that is a majority shareholder.

A major mistake that buyer’s make when acquiring a company is that they do not sell the seller. More often than not, when a buyer approaches a target for the first time, they are turned down for one reason or another. The most common reason revolves around the buyer’s long-term motives for the company. If a seller does not have confidence that the buyer will uphold certain company philosophies, then the deal can easily fall through. Studies have shown that sellers are willing to accept a marginal reduction in price in exchange for certain reassurances. If the buyer is keen to acquire the company, it may be an essential step in the process to sell the seller. Therefore, as a buyer, the best way to increase the likelihood of a successful transaction is to be persistent and always sell the seller.

Sell the seller can manifest itself in many forms. At a superficial level, buyers should always take the time to develop a positive rapport with the target. This will allow the buyer to better understand the seller’s goals for a potential transaction. With this knowledge, the buyer will then be able to effectively tailor their pitch to fully resonate with the seller. Moreover, the buyer should convey, throughout the deal process, that they value the company’s stakeholders, i.e., customers, employees, suppliers, etc. Sellers want to know that their employees, customer relationships, brand image, etc. will not be sacrificed for synergy once the deal is completed. Buyers can help mitigate this concern by introducing the target to satisfied sellers from past deals. The successful application of “sell the seller” may be the defining factor in convincing the owner or seller to accept your bid.

Regardless of the technique, sell the seller requires creativity on behalf of the buyer. No one seller is the same. Every transaction needs to be approached in a new and unique way that specifically targets the seller’s motives. This often involves providing the seller certain assurances that the integrity of their company will not be exploited after closing. If accomplished correctly, this technique of selling the seller can act as a powerful differentiator in the competitive process of buying a company. An M&A firm with years of experience on both the buy and sell side will be able to guide you through this process adroitly and successfully.

M&A Deals - The Power of Multiple Buyers

M&A Deals - The Power of Multiple Buyers

In M&A deals - the power of multiple buyers should never be discounted. In fact, having multiple buyers is an essential ingredient to a successful transaction.

The proper way to sell a business is for the M&A advisor or investment banker to prepare a Confidential Information Memorandum (“CIM”) on the company to be sold. The CIM will give the potential buyer an in-depth look at the company. However, before the buyer sees that document, the investment banker will prepare a “teaser,” which will enable them to generate interest in the company without disclosing the company name, location, or other revealing details. The M&A advisor will prepare a list of potential buyers who will receive the teaser in order to maximize the power of multiple buyers.

When prospective buyers see the teaser, they decide if they’re interested. If they are, they execute a Non-Disclosure Agreement and receive the detailed CIM. Most buyers have questions after reading the CIM and the investment banker either answers them directly or sets up a conference call with the seller. In other cases, informational meetings are held where the seller gives a management presentation and the buyers ask questions.

In any case, if the prospective buyer is serious and very interested, they will submit a Letter of Intent (“LOI”). The LOI outlines the value and basic terms/conditions for the purchase. Unless stated to the contrary, LOI’s are non-binding. Usually, a buyer will make certain clauses binding to protect themselves. Similarly, the seller will want certain provisions to be binding.
Sometimes sellers become overly excited when they receive their first LOI, especially if the price/terms are favorable. Sellers should always consult with their investment banker as to the advisability of accepting the first offer. Committing to the first buyer eliminates the chance of negotiating a better deal with that one buyer and ruins the chance of developing the other buyers, just in case the original buyer fails to close. Most importantly, the whole objective of the sales process is to create an auction whereby all of the buyers would compete. Accepting the first offer circumvents this important step in creating a superior transaction. It violates the basis rule of M&A deals – the power of multiple buyers.

Versailles Group firmly believes that if a seller has one buyer, they have no choice. If the seller has two buyers, they have a dilemma. It’s only with three or more buyers does the seller have true choice. With only one buyer, the seller has no leverage, which means that the closing takes longer and the buyer will feel free to keep negotiating the deal or even just walk away. Thus, many investment bankers say “one buyer is no buyer.”

To summarize, an experienced M&A advisor will know how to conduct this process efficiently and effectively. That being said, many firms believe that the process is like a recipe or treat it like a “cookie cutter.” The basic process works, but it always works better if the investment banker has a flexible program that can accommodate the normal twists and turns that take place in today’s fast paced world. That’s really the only way to maximize the power of multiple buyers. Versailles Group has closed many transactions because of its unique ability to run these processes in a manner that maximized value and terms and met or exceeded the sellers other objectives. Thus, M&A deals – the power of multiple buyers should always be maximized.

M&A Bubble? - US Middle Market M&A Activity

M&A Bubble? - US Middle Market M&A Activity

Middle Market M&A activity in the United States is at its highest levels since 2009 when the Great Recession interrupted deal-making.

These two charts show the volume and value of U.S. Middle Market M&A activity for the last 10 years, which leads to the question, M&A bubble? - US middle market M&A activity?

US Middle Market M&A Volume Since 2005

US Middle Market M&A Transaction Value Since 2005

M&A advisers are beginning to question whether transaction activity will continue to expand or is it a bubble that might burst at some point in the near future. No one has the answer to that question; however, there is certainly plenty of evidence for both scenarios. We’re finding that those parties that remember the “pain” of watching the value of their business deteriorate in the Great Recession are taking advantage of the strong M&A markets now.

What’s your opinion on M&A bubble? - US middle market M&A activity? Please send us an e-mail dgrava [at] versaillesgroup dot com, if you'd like to express your opinion. Thank you.

Regulation D – Reg D

Regulation D – Reg D

Private placements refer the issuance of either debt or equity securities to investors in the private market. Private placements are an effective way for small companies who have limited access to the capital markets and/or bank lending to secure financing. Because private placements are non-public transactions, they are considered “exempt transactions” by the SEC which allows them to avoid the high costs and lengthy timetable associated with registering securities. One way an issuer can obtain a private placement exemption is through adhering to the rules set forth in Regulation D, or Reg D.

Briefly, Reg D lays out a basic set of rules for private placement transactions. First off, sufficient information must be provided to all potential investors and the SEC so that a potential investor can make an informed investment decision. Additionally, there can be no general solicitation or resale of the securities without registration. Since the securities being offered are not intended for resale, they are classified as “restricted.” Lastly, any securities sold within a specific time period are treated as one offering under Reg D. After these rules are satisfied, the issuing company must file a Form D with the SEC. The Form D prohibits any sort of public solicitation or advertising for the securities, such as television ads or seminars.

Reg D also contains specific rules depending on the size of a private placement. Rules 504, 505, and 506 refer to offerings of up to US$1 million, up to US$5 million, and over US$5 million, respectively. Rules 505 and 506 specify that only “accredited investors” and up to 35 non-accredited investors can purchase the securities. An accredited investor may be an institutional investor or a common retail investor, if the retail investor meets certain standards. Some of these standards include a net worth of at least $1 million (less net equity in their primary residence), an income exceeding $200,000 for the past two years, and so on. Moreover, rule 506 states that any investor who is not “accredited” must be “sophisticated.” Sophisticated investors are individuals who possess both experience in finance and the knowledge to properly evaluate the risks of a given investment. To clarify, rules 504 and 505 do not require all non-accredited investors to be sophisticated; this distinction only applies under rule 506.

Private placement financing’s primary benefit is that it provides the necessary financing to help growing companies. While there are many rules surrounding private placements in the form of Reg D, these rules play an important role in ensuring the suitability of an investment. Through controlling the solicitation, resale, and investor pool for private placements, legislation like Reg D serves to protect small investors from making inappropriate investments.

Any company that wants to perform a private placement should make sure that they are dealing with a registered broker-dealer. It is illegal for other types of firms to assist companies in these types of transactions. Versailles Group has and affiliated broker dealer, VGL Global LLC, which is a registered broker and capable of completing a private placement. VGL Global’s website is www.vglglobal.com.

Real Estate Investment Trusts

Real Estate Investment Trusts

A real estate investment trust or “REIT,” is an entity that owns and operates a portfolio of real estate properties or mortgages. REITs can be classified into three main categories; equity REITs, mortgage REITs, and hybrid REITs. Equity REITs have ownership of the properties in their portfolios and collect revenue via rent. Mortgage REITs will purchase mortgages, invest in mortgage backed securities, or issue mortgages to property buyers. All of these activities generate revenue via interest on the mortgage payments. Lastly, Hybrid REITs are a combination of equity and mortgage REITs that generate revenue using a combination of both strategies. REIT securities are commonly sold on public exchanges, offering investors access to a liquid means of making real estate investments. It should be noted that some REITs do not trade. In these cases, the REIT itself has certain rules around redemption. It’s very important for the investor to know what these rules are as redemptions outside of those rules is not allowed. Most importantly, the value is also dictated by these rules.

In order for a company to be classified as a REIT, certain rules must be followed. First, the REIT must invest at least 75% of its total assets in real estate. Additionally, the company must gross 75% or more of its revenue through these real estate investments. As aforementioned, these revenues are commonly in the form of the collection of rents or as interest on mortgages. Finally, the REIT must pay out at least 90% of its taxable income to shareholders, usually in the form of dividends. This generous dividend is another attractive feature of a REIT investment.

REITs are tax advantaged investments which avoid double taxation of income. Any dividends distributed by the company are considered tax deductible and vastly reduce the level of taxable income the REIT pays. For example, a REIT that distributes 90% of its net income in the form of dividends will be taxed on only 10% of its total net income as a result of the exemption.
If you are considering an investment in a REIT, it’s highly advisable to seek the advice and counsel of your broker or wealth advisor. REITs can be a very good investment, but probably aren’t for everyone and certainly, the investor should do their diligence.

Dutch Auction

Dutch Auction

In a Dutch auction, each individual bidder will end up paying the same price as their competitor. During an initial public offering (IPO), the prospective investors will place orders for the number of shares they want and the price they are willing to pay per share. The price that the shares will be sold at or the clearing price is determined by the price at which all of the shares in the offering will be purchased. Investors who bid higher than the clearing price will receive the number of shares they ordered at the clearing price which may actually be lower than the price they were willing to pay. Investors who bid lower than the clearing price will receive no shares.

Some people believe that Dutch auctions are better than traditional auctions because the quantity of shares an investor is willing to purchase will not determine whether or not they receive those shares. It is considered more democratic since the price is the only determining factor. For example, if a larger company placed an order for two million shares at a price that fell below the clearing price they would receive zero shares. On the other hand if a small investor placed an order for only two hundred shares but they bid at or above the clearing price, they would receive those shares at the clearing price.

In a typical IPO the price of the shares rises as bidders compete for shares. By contrast, in a Dutch auction, the price of the shares is lowered until the clearing price in which all of the shares will be sold is determined. Therefore, if an investor bids one hundred dollars per share but the clearing price was determined to be seventy dollars per share, then that investor would only have to pay seventy dollars per share as opposed to the one hundred they were willing to pay.