Working on the Buyside in M&A can be like searching for a needle in a haystack, particularly if your responsibility is the origination of the deal (often the most difficult).
I thought it would be helpful to share some of my thoughts and my approach to the problem.
I have been doing some buyside M&A preparation this week in the Technology Financial Services Sub-Sector and thought this would make a good case study.
Using the Six Minute Strategist Methodology, lets split this into Six Steps.
- Objective Setting
- Landscape Defining
- Short Listing
You will note this stops at the point at which the first discussions take place between the target company and myself and/or my client.
I have prepared a brief video for you to watch before you decide whether to read the blog post (of course, I hope you do!!!)
It is critical from the outset to have a clear understanding with your client of the type of business that fits their strategic criteria.
What are the Client’s Strategic Objectives?
- Technology: what technologies should we focus on?
- Client Base: what type of clients should the target have? Is this in part a client acquisition strategy?
- Geography: is the location of the business or the geography they cover a significant issue?
- Financial: Size – Revenues and Profits? Profitable or Turnaround? Does the deal have to be financially incremental on day one? Note: this is not about valuation but about the financial characteristics of the target company.
- Competences: what skills and competences should the target bring with it? This does tie back to technology in part but we want to consider here how the target company fits into the client company’s own competence lattice.
- Business Model: what business model does the target employ and is this compatible with the client’s own business model?
At this point it is also illuminating to establish my Client’s main competitors. This not only acts as a reference point but also enables me to look at what these competitors are doing and the acquisitions they have made.
Their strategy can be an important part of the discussion with the client to better understand the thinking behind the client’s strategy.
It is also important at this point to have a discussion about some of the major trends which are defining change in the industry. Strategy should be about insight fuelled by information and knowledge.
Strategy should anticipate change not react to it. (Click to Tweet)
By taking a broader view of up coming opportunities and threats, company’s should be positioning themselves to meet these challenges before their businesses are damaged by innovation and change.
Available Financial Resources
The other major issue you should broach with your client at this point is the question of Available Financial Resources – how are they going to fund any deal. This is a key question that any potential target company owner will want a very clear answer to. In an ideal world, your client will have the cash resources or a pre-agreed bank arrangement to provide the cash to make the acquisition. If your client is a public company, they may need to go to the market to raise the cash. If a Venture Capital or Private Equity firm is an existing investor, they may have earmarked additional financial resources for acquisitions.
In any event, finding a deal is a pointless exercise if your client cannot fund it and proposing a deal structure which is a combination of earnout and vendor loans is a very weak proposition.
The available resources will also provide another boundary to the acquisition criteria.
It is as well to agree early the members of the Client’s M&A Deal Team. Who will be responsible for the project. This may be the CEO but in larger companies it is more often either a senior executive responsible for M&A/Business Development or the Finance Director. Establishing a clear chain of command is important, as is securing the Client’s commitment to dedicating the necessary manpower resources to the time the project will require.
It is also useful as well to establish an early relationship with the company’s legal and accounting teams both internal and external.
Following the initial approach be prepared for:
- Several Meetings
- An exchange of Non Disclosure Agreements
- An exchange of detailed information about the target
- Business and financial evaluation of the target by the Client
- Signing of a non binding Letter of Intent
- Due Diligence
- Further negotiations
- Deal Documentation
Deal Origination is a time consuming process. This post is focusing on the process up to the point of initial contact with the target company. This may take between four and eight weeks. From this point a deal can take between a further 8 to 16 weeks, the whole process can be a six month project.
In the two deals I successfully concluded with CIBER, the UK deal started in January, I had initiated contact with Ascent Technology by the end of February and we closed in May. This was a relatively straight forward deal and it took five months. In the Novasoft deal I started the project in February, we had our initial meeting with the controlling shareholders within two months but did not announce the deal until September and then the acquisition of the outstanding minority (a public company offer in Germany which we did not handle) took another 18 months, primarily due to the complexity of the regulations and the lack at the time of a squeeze out provision in the German Corporate legal code.
It is a fact that public deals take longer, can be more complex to arrange and are more expensive to consummate than private company transactions.
Defining the Competitive Landscape is a key step. My approach is to try to identify as many possible candidates as possible and then eliminate those which are not suitable. This involves creating structured lists of potential target companies and then screening them (the next step).
To identify target companies I use a combination of my own existing research – I have been researching the Technology Sector since 1998 – and further online searches to bring my data up to date.
My existing databases include:
- Companies House Data
- UK Mid Market Technology Databases
- Partner lists from Technology Partners
- Exhibitors at relevant Trade Exhibitions
- Growth Company Tables
- Venture Capital and Private Equity Portfolio Databases
- Financing Databases (companies who have raised rounds of external finance).
In defining the landscape the sort of information I am seeking to accumulate in the first instance would include:
- Business Summary: to understand the fit with the Client’s strategic objectives. In technology there is often a blurred line between Software and Services companies. Many Services Companies have originated or claim to have originated differentiating Intellectual Property (IP).
- Business Model: It is also important to understand at what point in the business process food chain the business operates. Examples include Strategic Consulting, IT Consulting, Systems Integration, Managed Services, SAAS, Outsourcing.
- Income Model: How does the target company make money: consulting and/or project fees, support contracts, recurring revenues from licence fees or SAAS. A business with regular recurring income from its client base is always going to be a more attractive potential acquisition than one who relies on one off project income. Often companies have a blended model.
- Vertical and Horizontal Competences: A vertical competence might be a sector expertise, a horizontal competence might be Human Resources expertise. Understanding a target company’s competence matrix is crucial in this process.
- Revenues: to give some indication of scale, perhaps headline financials but at this point it is more about establishing the scale of the business.
- An indication of employee numbers also helps to do this.
- Technology Partners: again to match to strategic fit. In some cases the client is looking to reinforce a competence in others to add to their existing competence by acquiring a company who can bring new skills.
- Website URL: to review later
- Ownership: external shareholders, public or private
- Sector: Sector and Sub-Sector Focus. In the financial Services Sector, which is particularly complex this is important. One sector database I have built for Financial Services has 19 Major Sectors (within Financial Services itself) and 148 Sub Sectors.
- Head Office Location: by postcode which I can map
- Office Locations: Which markets do they address, often its more than one. It is also important to try to understand which are the major centres of activity and which are satellite operations.
These factors are intended to enable me to match or eliminate potential targets against my client’s strategic criteria. It is worth stressing too that the object of this exercise is not to create the perfect database but to identify companies and gather sufficient information on them to make the next stage of the exercise possible. Often, if a company is clearly a non runner, little further investigation will be made.
The first pass on screening focuses on eliminating as quickly as possible as many potential companies as possible. I have produced a brief video to illustrate how I can take complex data sets and do some very fast screening to eliminate companies which do not meet my criteria.
Factors such as wrong location, too small, wrong business model, incorrect competences, wrong technology partners, ownership (may already be a subsidiary company and therefore unlikely to be for sale)
When looking at companies who are at the cutting edge, this can be more difficult. Particularly in Technology Financial Services there is a great deal of innovation and change and identifying a relatively new company who has developed a new piece of distruptive technology can be very value adding to an established business with a strong client base.
Ranking: Having completed the first initial screen, I then rank the remaining companies so that I can assess those with the most likely fit first. This involves spending more time looking at their business activities, spending some time reading their website, their press releases and what ever information they have put in the public domain.
Strategic Fit: While Google is an excellent tool for gathering further information, this process is about making judgements to confirm or eliminate the businesses from the list using the client’s strategic criteria and selecting companies based on the closeness of their fit to that criteria.
Age: I often look at the age of the company and its owners/directors? How long has the company been established? Are the owners at a stage in their lives where cashing in and retiring is beginning to look like an attractive proposition. Owners and Directors in their thirties may still have an appetite to continue working in the enlarged business so this does not itself eliminate them from consideration but asking whether retirement is being considered can be a useful opening gambit.
Ownership: Are the major shareholders husband and wife who will have a significant part of their total net worth tied up in the company? Are there external shareholders. I like to see Venture Capital or Private Equity firms on the shareholder register but not passive private investors who may not want to sell the business. Public companies are not eliminated at this stage per se, but being listed means that the acquisition will require some form of public offer for the shares which is more time consuming and costly for the acquiror.
Track Record: I look at the historic financial track record of the business to see whether its recent trading history has been a successful one and whether the company has a strong balance sheet. Often for smaller companies this information is not available but one can look at trends in balance sheet items which are made public as an indicator.
The objective of this part of the process is to further filter the list and eliminate or sideline companies that do not tick enough of the Strategic Objective Boxes established at the start of the process.
The Refining Stage involves spending more time evaluating the short listed candidates and starting to ask whether the companies are likely to be for sale.
Some of the factors here (in no particular order) include:
- Reason for a Sale: Death, Disease, Divorce are often cited as three of the major reasons companies are sold. Often a decision to sell is triggered by some form of life event and having a willing seller is not as good as having a needy seller. In any event, it is important to establish that the seller is willing to sell (presumably at the right price) and is prepared to commit to the process. Without this you and your client can spend a lot of time negotiating a deal without any real intent to close on the other side.
- Valuation: On exit, company shareholders are often looking to make life changing money to reward them for thier hard work. Smaller companies do not always command sufficient valuations to make this possible and as a rule of thumb deals below £5m seldom achieve this objective for their sellers.
- Shareholder Structure: a single majority shareholder makes it more likely that a deal can be negotiated. Where the shareholder structure is split between a number of different minority shareholders, getting collective agreement on a deal may be difficult unless provision has been made by the company to clarify the level of support needed in a shareholder vote to agree to a sale of the company.
- Financial Performance: in these straightened times, when bank financing is not as readily available as it once was, companies with weak balance sheets or showing weeak historical financial performance, may be ready to consider a deal.
- Financial Analysis: Given a base set of data (revenues, profits, assets, current assets, current liabilities) it is possible to create primary ratios (profit margin, gross margin, debtor days) and secondary ratios (return on shareholders funds) to better analyse and understand the quality of a business. Depending on the business model, companies are either highly profitable or moderately so, require significant working capital or relatively little). This kind of analysis can tell us much about how well a company is run, compared to what you would expect for a typical business of that kind. It is also possible to graph some of these ratios and look at the outliers and understand why they do not fit a standard pattern – for better or for worse. The relationship between Gross Margin and Profit Margin can also be a telling one.
- SWOT Analysis: It is sometimes useful to summarise a potential target in the form of a short SWOT analysis – Strengths, Weaknesses, Opportunities and Threats. When presenting a short list to a client, this form of “Executive Summary” is a good way to communicate why the target has been selected.
The approach is the last step in this Six Step Process.
No Names Basis: The first point to make here is that any contact with the owners or directors of the company is made on a no names basis – that is to say the client name is not revealed. This particular Rubicon is only crossed once we have confirmed that the target company may be a suitable candidate for a first meeting.
Social Media Tools: I use a combination of my existing network and online tools such as Linkedin to make approaches. In the past I have sent Twitter messages to ask for a private conversation offline to good effect.
Introduction: The power of Linkedin is the ability to reach a Second degree or sometimes even a third degree connection through the platform which makes it possible to see these connections. Many companies also have company pages which enable you to see who has a Linkedin account and while it may not be possible to reach the main shareholder first time, it is often possible to reach out to another Board Director to make initial contact
Direct Approach: Linkedin Groups also enable direct contact. If it is possible to identify the group that someone is in, then a direct message can be sent to them through the group.
Previous Contact: I have kept extensive logs of my phone records from the past and I often go back to these to re-approach someone I have spoken with in the past, even years before. “I know we have not spoken since May 2004 but…” is often a good opening line.
Cold Call: when all else fails, I just pick up the phone and call the company and ask to speak to the Managing Director/CEO/Chairman/Main Shareholder/CFO. Most Executives will take a short call providing I make it clear that the call is:
- On behalf of a third party
- Not a Sales Approach
- Will take no longer than 5 minutes
The biggest challenge is sometimes getting past gate keepers which can be done by either calling out of normal working hours or sending a brief email to them once the email address has been obtained or worked out. All companies have a standard email convention and once you know one email, you have a high probability of deducing other peoples email address. This sometimes fails if a second or third initial is used in the email address. In any event, it is always worth sending this email to several senior executives at the same time and explaining in your message this is done as it is not clear who is the most appropriate person with whom to have the discussion.
It is not unusual to have to make several calls/approaches to a single company and to use a combination of these techniques in order to get through. Persistence pays.
Art or Science?
It is always possible that you stumble across the ideal acquisition target or a suitable opportunity immediately comes to mind when the initial client discussions are held. My experience tells me that this is not the case.
Deal Origination is more of a science than an art and I firmly believe that a structured and rigourous screening process is the way to identify the elusive needle in the towering haystack.
I have prepared a summary presentation of this Blog post which is available to you to download.
If you would like to talk further with me about Buyside Deal Origination, why not email me (john[at]jbdcolley[dot]com) or call me on my phone – 07813 672 612. I would be delighted to continue to this conversation with you offline.
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