M&A Mistake #4: Lack of Preparation
First-time sellers are often surprised by the amount of work that needs to be completed at the beginning of an M&A process. Having labored over the decision to sell their business for months or even years, once the decision is made, they expect buyers to be contacted and the process to begin in earnest. They think that the hard part is deciding to sell. Once they’ve decided, they think they’re ready to roll. It’s not just them. Even private equity firms, whose business it is to buy, improve, and then sell private companies, are tempted to take shortcuts in the preparation phase in a rush to get to market. Don’t fall into this trap. This strategy is almost always short-sighted and guarantees, in the best case, that problems will arise later in the process, or in the worst case, that the transaction process will fail. As we can see from these two scenarios from Chapter 6, the lack of preparation can cause major deal issues later on in the process.
In our first scenario, Company X wants to present as aggressive an earnings base as possible as a tactic to drive higher valuations. So, during the preparation phase, the company’s owners hire a top management consulting firm to review the three most recent acquisitions that Company X had closed within the past six months and identify potential cost-saving synergies that could be realized by fully integrating the acquisitions into the parent company. Though the steps to realize these cost-savings have not yet been taken and significant execution risk still exists, Company X’s owners insist on including these pro forma savings in the financial adjustments in the CIM. As a result of these pro forma addbacks, EBITDA increased from an as-reported $10 million to an adjusted $14 million. The owners were excited to have buyers start bidding from an adjusted EBITDA $4 million higher. The decision to take such an aggressive position with the EBITDA adjustments would ultimately backfire, however. During the initial round of bidding, buyers accepted at face value the $14 million of adjusted EBITDA and applied valuation multiples as high as 10x, or $140 million. Ten buyers were selected to move forward in the process to meet the management team and gain access to more detailed financial information, where they learned that $4 million of the EBITDA they had based their valuation on was not actual earnings but potential cost-saving synergies. Feeling like they had been materially misled, four of the buyers dropped out of the process entirely and the other six lowered their bids significantly. Now, their bids were based on the actual EBITDA of $10 million, and they also lowered their multiple to 9x, yielding a $90 million valuation. Of course, the owners of Company X, which based on the first-round bids had been focused on selling the business for $140 million, were not excited about selling for $50 million less than expected. Ultimately, they called off the process because buyers could not meet their valuation expectations, which regrettably were never achievable to begin with. Our second scenario takes an entirely different approach to preparation. Beginning with the same $10 million of unadjusted EBITDA in the same industry, Company Y’s management works with their investment bank to make only a few highly defensible EBITDA adjustments, totaling $1 million and takes the time to build a cache of documentation to support each one. They also think critically about how buyers will view their business, identify areas of their company and business model that may be considered weak, and build mini-presentations to proactively describe how they are addressing each of these weaknesses. They also work with their investment bankers to create high-level five- to eight-page presentations and supporting analyses to provide depth and commentary on each of the five growth strategies that management discusses in the CIM. When all this information is fully proofed and ready, only then are buyers contacted. Buyers are equally enthralled with Company Y and bid 10x the adjusted EBITDA of $11 million, or $110 million. During management presentations, the groups are given access to the in-depth presentations on growth and strategies for addressing weaknesses that had been prepared in Phase I. Buyers were impressed with the information, but it also allowed the seller to dictate timing to keep a sense of urgency and forward momentum, as well as easily facilitate multiple competing buyers. The management team gave a great impression to their potential new partners because they didn’t need to research answers to questions on these topics while buyers waited for it; they could build it ahead of time when no one was looking over their shoulder. With solid grounding for pricing and a new level of confidence in the management team inspired by the proactive analyses, several buyers increased their valuation multiple to 11x, or $121 million, and one buyer even offered to close on an expedited basis three weeks earlier than the competing buyers. The transaction successfully closed earlier than expected, even accounting for the extra time invested in Phase I preparation, at $121 million, significantly higher than Company Y’s owners had expected.
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