Must know M&A advice

Recently an investment banker named Tom Metz was kind of enough to share his book with me entitled “Perfect Your Exit Strategy”. It’s about going through an exit with an investment banker. Below are direct quotes I found most informative.

Plan for the exit. “Business owners should begin thinking about their exit strategies two to four years ahead of time.”

Sell when you’re growing. “The best time to sell is when the company is doing well and enjoying excellent growth and profitability. This is when the firm can sell for top dollar. Of course, few businesses want to sell when this is the case. They are enjoying the ride. Companies usually want to wait for the growth to slow before selling. In my experience, companies usually wait too long before deciding to sell.”

Value > Risk. “… the company should continue building when the value being created outweighs the risks of staying independent.”

Timing is critical for strategics. “Time is often a component of strategic transactions. A buyer may want a particular technology immediately because of market conditions or competitive pressures. A company may be willing to pay a premium if it can acquire the technology now.”

Mid-size buyers are best. “One of the mistakes that I have seen over the years is that small companies believe that the largest companies are the best buyers for them. As a result, they end up focusing on the wrong companies. It is much better to focus on the midsized and smaller buyers even though these companies are not as visible.  A small acquisition will rarely make an impact on a $1 billion company. So unless your company has revenues greater than about $30 million, it is not productive to reach out to large buyers. It is simply too small to get their attention…….An acquisition is an excellent way for a midsized company (with revenues from $150 million to $500 million) to add capabilities and expand into new markets. A midsized buyer acts a lot like a big buyer; however, the midsized buyer will consider a small acquisition of $10 million or $20 million if it achieves a strategic objective.”

Small buyers are right for small deals. “Small buyers are best for small acquisitions. A $5 million or $10 million acquisition is an important transaction for a small buyer. “

Competitors wont pay up. “Competitors are rarely the best buyers. Even if the seller’s technology is superior, it is unlikely that the competitor will replace its current technology with the seller’s technology. Consolidation is the typical reason behind acquisitions made by competitors. Acquisitions in a consolidating industry are usually made to gain customers. These types of transactions generally do not pay high prices because the customers are the only real asset.”

You don’t know the best buyer. “Many times the best buyers are not in the selling company’s primary market; they are in adjacent markets. In addition, the best buyer may not be the first company that makes you an offer…..Sometimes the best buyers are not in a company’s core market space, but in the little spaces off to the side, in neighboring areas. Don’t assume that you know who the best buyers are. Sometime nonobvious buyers in adjacent markets can be excellent buyers.”

All employees need employment agreements. “New employees should sign noncompete agreements too. Most buyers will want senior and technical employees to have signed a good, modern employment agreement.”

Get rid of litigation. “As mentioned earlier, potential litigation is almost always a deal killer. If you have any potential litigation, do everything in your power to settle or eliminate this issue before you begin the process of selling the company.”

Be up front. “The buyer will eventually find out anything and everything about your company so upfront honesty will go a long way. You might as well be frank about it. There are no perfect companies. Being straightforward will help build a relationship with the buyer based on truthfulness and this is a good thing.”

The process is rocky. “Almost every deal blows up at least once. After verbal agreement, there is only about a 60% chance of successfully closing the transaction.”

Limit the negotiating. “Unseasoned negotiators make the mistake of thinking that if they ask a high price, they will be more likely to obtain a high price. This is rarely the case … My advice is to get as many offers as you can and then take the highest one.”

You wont be hot for long. “Too many CEOs think about value in financial terms, not strategic terms. The mindset is: “If we wait, we will be worth more.” For technology firms, the strategic value is typically greater than the financial value so waiting does not necessarily increase the value. Waiting for better financial performance is not usually a good plan. For a company with strategic value, the buyer is seeking technology and capabilities, not revenues or cash flow.”

Use a banker. “An objective third party can help defuse unreasonable claims, establish a constructive atmosphere and minimize extreme posturing. Friction can develop in negotiations. To avoid an adversarial relationship, let an intermediary handle the negotiations and be the bad guy.”

This is critical. “In addition to the basic price and terms, the LOI includes information about not hiring away employees and a no-shop clause. In the no-hire clause the buyer promises not to try to hire any of the seller’s employees.”

Asset versus equity sale. “Buyers prefer to purchase assets on small transactions because it reduces the possibility of unknown liabilities. The C Corporation itself must pay taxes on the gain for a sale of assets and then the shareholders must pay taxes when they receive the proceeds from the sale.  In one transaction that I was involved in, the deal actually fell apart because the buyer wanted to purchase assets, not stock. The selling company was a C Corporation and it had to pay taxes on the gain and then the three founders had to pay additional taxes individually.”

Accounts payable will be assumed. “It makes sense for the buyer to assume accounts payable – because it wants to make sure the bills are paid. The buyer wants to maintain good relationships with the customers so it will usually assume the accounts receivable and any service contract liabilities. The buyer will not assume past payroll obligation, deferred compensation or professional fees.”

Stock swaps. “If a company trades its stock for stock of the buyer, the transaction will be tax free in most situations. If stock is sold for cash, the shareholders will have to pay taxes on the capital gain.”

You aren’t going anywhere for now. “Consulting contracts are made with key management people to help with the transaction period. These contracts typically last from six months to as long as two years. Noncompete agreements are standard in the sale of companies. By signing a noncompete agreement, an employee agrees not to work for a competitor for a period of time.”

Earnouts are ok. “An earnout can be a versatile tool to bridge the price gap between what a seller thinks his company is worth and what the buyer is willing to pay. In other words, they can’t agree on price.”

Tax makes things adversarial. “The buyer and seller must use the same amounts for each allocation. Generally, what is good for the buyer is bad for the seller and vice versa.”

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