Private Placement

Private placements are securities offered by issuers to a select group of potential buyers rather than the open market. Since these securities are not available to the public, they are usually out of the scope of SEC registration and are considered exempt transactions. Although these securities are private, they are still subject to federal securities anti-fraud regulation. In order to qualify for private placement exemption, purchasers of the securities must be sophisticated investors, have access to information normally provided in a prospectus, must be able to bear the investment’s economic risk, and agree not to resell or distribute the securities to the public. Since the placements are private rather than public, the average investor is usually only made aware of the placement after it has occurred.

Venture Capital

Venture capital is a segment of the private equity industry that focuses on investing in new companies with potentially high growth rates. Venture capital firms are an important source of funding for startups that do not have access to capital markets. Venture capital investors provide money to start-up firms and small businesses with perceived long-term growth potential. In return, these investors typically receive equity in the startup and a seat on the company’s board of directors. Venture capital investments are extremely risky but also have the potential for above average returns. Most venture capital comes from a group of wealthy investors, investment banks, and other financial institutions that put together their investments or form partnerships.

Developing Acquisition Criteria

Once a company has determined that acquisitions are going to be the most cost effective way to increase shareholder value, the next step is to develop criteria for potential acquisition targets. This will serve as a guide, but it’s important to remember that one needs to be flexible.

No target will fulfill every requirement. As we say, a buyer needs to be optimistic and opportunistic if a successful transaction is going to be completed. It might be a good idea to rank the criteria so that one has an idea of what the most important objectives are to the buyer. This will help the buyer navigate through the potential targets faster and more efficiently.

The type of questions one should ask in order to develop criteria should fall under the following categories: general, operating, and financial.

General
In terms of general criteria, there are many important questions to consider. Is retaining management important? How important is the geographic location of the target? How much ownership is the buyer willing to accept if less than 100 percent? Are the corporate cultures compatible?

Operating
When thinking about operating criteria, what products and industries are you interested in? Is market share important? What kind of distribution channels does the other company have? How advanced is the acquisition candidate’s technology?

Financial
With regard to financial criteria, one needs to be clear on the objectives. What kind of revenues and growth rates are you looking for? What is an acceptable debt-equity ratio? What kind of multiple are you looking to pay and is that a multiple of EBITDA, revenues, etc.? How are you looking to finance the acquisition? Would you be willing to pay an earn-out? Does the acquisition need to be accretive right away?

This is a very short summary of the items that should be considered when considering an acquisition. Obviously, some criteria will have greater importance than others depending on the buyer’s strategic goals. Your M&A advisor can help you develop the acquisition criteria, identify and contact the targets, and conduct sophisticated financial modeling and analysis of the potential target. The success of the acquisition starts with the search criteria and will be enhanced by additional analysis.

Initial Public Offering

An initial public offering or “IPO” is the first offering of stock by a company to the public. By completing an IPO, the once previously private company will become publically traded, subjecting it to additional regulatory pressures and costs but also allowing it greater access to the capital markets. A successful IPO will raise a large amount of money for the issuing company, which can be used for growth initiatives. By completing an IPO, the company will oftentimes receive better rates on its debt issuances due to increased transparency of the firm, making further funding less costly.

Secondary Offering

A secondary offering occurs when a publicly traded company issues additional shares to the public. This can be done in order to raise additional funds for growth or to accomplish a refinancing. Secondary offerings may cause share prices to decrease as more shares of the company’s stock are now available on the market. Another form of secondary offering occurs when founders of a business would like to decrease their ownership positions in the company. This type of secondary offering is usually done over time as to not exert too much downward pressure on the company’s share price as a result of the increased selling volume. This type of secondary offering does not dilute current owners’ holdings in the company unlike secondary offerings in which additional shares are issued.

M&A volume in 2014 was dramatically higher than 2013. In 2014, almost US$4 trillion of transactions were completed versus US$2.6 trillion in 2013. By volume, 43,613 transactions were completed in 2014 versus 40,783 transactions in 2013.

Graphically, here’s a look at the increase by quarter.

By sector, Financial Services, Healthcare, and Energy/Power were the most active.

M&A Auctions

An M&A auction is the process of presenting a company that is for sale to potential buyers. There are two different types of auctions, broad auctions and targeted auctions. There are several advantages and disadvantages to each approach.

Just as the name implies, a broad auction is designed to reach out to as many potential buyers as possible. Your M&A advisors, if he or she is well-experienced, should contact hundreds or even thousands of prospective buyers worldwide. This list should include both strategic and financial sponsors. The goal of this strategy is to maximize the competitive dynamics of the sales process to increase the odds of finding the best possible offer. It helps to ensure that all possible bidders have been reached and it limits potential buyers negotiating leverage. One of the concerns with this approach is maintaining the confidentiality of the transaction. Of course, an experienced M&A advisor will know how to conduct this type of auction without breaches of confidentiality and if done properly, this approach will insure the sale of the company for the best value and terms.

A targeted auction is when your M&A advisor focuses on a few clearly defined buyers that are identified as having a strong strategic fit. These buyers should also be vetted to make sure that they have the financial resources to acquire the company. With a targeted auction is it much easier to maintain confidentiality and minimize any possible business disruption from the process. However, there is a much higher chance that the best possible value and terms will not be achieved due to the limited auction. The only way to insure the best possible transaction is to make sure that all possible buyers, via a broad auction, are included in the process.

Your M&A advisor should be able to explain the pros and cons of each method and help the seller to make an informed decision.

Discounted Cash Flow Analysis or “DCF” is a valuation method used in M&A transactions in order to determine the value of a company for sale. This method projects the future free cash flows of the company for sale and then discounts these future cash flows to their present value. Cash flows received farther in the future have less value to the business today and so are discounted more than cash flows that will be received in the near term. DCF analysis is one of the most commonly used valuation methods in M&A. While this method can be very useful in determining the value of a company, it can lead to inaccurate valuations if the underlying inputs of the analysis are unrealistic. In other words, the outputs of a DCF analysis are only as good as the inputs used in it.

M&A transactions sometimes require financing and buyers must carefully weigh their financing options to ensure a successful acquisition, i.e., one that will not jeopardize their financial condition. It’s also helpful for sellers to understand why buyers offer equity versus cash or sometimes ask the seller to finance part of the purchase.

Two of the most common forms of financing for acquisitions are the use of debt or the issuance of equity to fund the acquisition. Given that there are advantages and disadvantages to each form, many buyers use a combination of the two.

Financing an M&A transaction through the use of debt can be appealing since it is typically cheaper for the company to issue compared to equity, which usually carries a much higher rate of return expectation from investors. Issuing debt has tax benefits because the interest payments are tax deductible and the increased leverage can also boost a company’s return on equity. Another benefit of issuing debt is that no additional shares are issued and so there is no dilution of ownership. On the other hand, there are many notable downfalls to financing through debt. The issuance of too much debt will hurt the company’s credit rating which would hinder its ability to borrow money in the future and would lead to an increase in the company’s cost of debt. Debt issuance may also be limited by existing lender covenants that set a restriction on the amount of debt the firm can assume. This might make it impossible for some companies to borrow enough money to make a large acquisition.

When equity financing is utilized, a buyer can either offer its stock to the target firm’s shareholders or offer cash, which would be generated by the proceeds from an equity offering. Despite the higher cost of equity, it is still very common in M&A transactions because of the flexibility it provides the issuers. Some of the benefits of equity include (i) no mandatory interest payments, (ii) no principal that must be repaid, and (iii) no restrictive covenants related to its issuance. Financing an M&A transaction with equity has no impact on a company’s credit rating therefore allowing them to issue debt in the future if needed. Equity offerings can however have negative side effects. Issuing stock can hurt a firm’s earnings per share and return on equity as it becomes less leveraged. Furthermore, the volatility of a company’s share price can cause uncertainty about the exact acquisition valuation, which in turn can increase the amount of time needed to reach a closing or even destroy the planned transaction.

Frequently, public companies use equity financing as their preferred form of payment in M&A transactions. Nevertheless, debt still plays an important role because of its cost effectiveness and the advantages of leverage.
An experienced M&A advisor can help buyers and sellers figure out the best combination of debt and equity for any particular transaction.

A Confidential Information Memorandum or “CIM” is used to market a business for sale to prospective buyers. The CIM or Offering Memorandum is usually created by the financial advisor of the business for sale and includes important information that a prospective buyer would need to submit an initial offer for the company. The CIM describes the business and its operations in detail, as well as includes the company’s financial statements. A strong CIM will highlight the company’s strengths and help prospective buyers understand the full potential of the investment. Normally, CIMs are not distributed to buyers until they have signed strict Non-Disclosure Agreement which prohibits the prospective acquirer from using any of the information for purposes other than the sale transaction.

There are several reasons why a company should make acquisitions. Listed below are some scenarios in which establishing an acquisition program can ensure your company’s continued success.

You may need to strengthen your position in the market if it is expected to have little or no growth or to mitigate competition. You may also want to “jump” into a related market or even venture into a new growing market.

You may decide that it is necessary to increase the size of your business through an acquisition to gain economies of scale. Doing this may allow you to keep up with larger competitors that qualify for better interest rates, access to commercial paper markets, and generally are able to get better terms for financing. By realizing these advantages through an acquisition of another company, division, or product line, one will be able to grow the business faster.

Another issue that some businesses face is that they sell a specialized product line to a limited number of customers. Due to market conditions, these customers in turn “force” the company to accept smaller profit margins. In turn, when suppliers see the company becoming less profitable they are less inclined to offer favorable terms for payment. Meanwhile, larger competitors that sell to a more diverse customer base or sell a broader array of products are not affected by these problems. The acquisition of another company is a viable option to expand the customer list or product line and avoid these problems.

The challenge is ultimately to understand how your company is positioned in the market and visualizing how you would like to position it in the future. It is important to accurately identify your company’s strengths and weaknesses so that you can eliminate or mitigate the weaknesses and enhance your strengths through an effective acquisition program.

With regard to M&A, due diligence is an audit of a potential investment, which takes place prior to the closing of a transaction. Due diligence is not only an opportunity for buyers to thoroughly examine the financial statements, physical assets, intellectual property, etc. of a potential acquisition, but is also an opportunity for the seller to assess the potential buyer and their ability to fund the transaction at closing. Due diligence is a critical step in the M&A process, as buyers use it to ensure they understand what is being purchased and sellers use it to become better acquainted with the potential acquirer.