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Written by: Alicia Chandler | Oak Street Funding
For business owners, there are many good reasons to understand the merger and acquisition (M&A) process, even if a purchase or sale isn’t in the immediate future. Every owner will exit their business at some point. Those with a clear grasp of what’s involved in selling their company will be several steps ahead of the competition whenever that time comes. Owners wanting to make a purchase will benefit from knowing how to approach an acquisition.
Reasons to buy or sell
Business owners acquire firms for many reasons, including to secure quality talent (acqui-hiring), increase their geographic footprint, or expand their client base or offerings. Sometimes they’re motivated by a combination of those reasons. Private strategic buyers (most of which are backed by private equity) and pure play private equity firms buy firms primarily for their investment value over a certain time window, typically five to seven years.
The primary motivation for an owner to sell is typically so they can retire or move on to a different business. A surprisingly large number of owners don’t have any formal succession plan in place, however. For example, among registered investment advisors (RIAs), the Financial Planning Association reported only 11% have clear retirement plans in place for themselves. This lack of planning can cost an owner a lot of money in the form of reduced valuation, limited offers, and lengthy delays in sealing a deal.
Challenges in M&A deals
M&A deals can be disrupted by unforeseen circumstances. Concentration risk (i.e., having too much of the company’s success contingent upon a single element) is one potential cause of such disruption. Take the example of a retail insurance agency where one client makes up 25% of its revenue. If that client goes bankrupt in the midst of the agency’s sale, the whole deal could go south, as the valuation of the agency would drop significantly. Similar situations can occur when there’s heavy reliance on one producer in the target firm and they leave the company.
Unrealistic timelines are another challenge. Often sellers wait too long to make a succession plan. When they do decide to move on, they may expect to sell right away without having laid the groundwork first. Ideally, if an owner wants to sell the business to an internal successor, the process of developing that person’s leadership and ownership skills should start several years prior to the owner’s planned exit date. That period can be a good opportunity for the successor to understand what is involved in operating the business and start buying in over time. There are lenders who can structure such a deal, using the current business as collateral for the loan.
How the M&A process works
Every situation is different, but most M&A deals can be broken down into three stages.
- Preparation – (About 30-45 days) The seller, their CFO, and their banker and/or M&A advisor organize the company’s financials to set the basis for an accurate valuation of the company. The team will create a one- or two-page anonymous fact sheet, along with a confidential information memorandum (CIM) and marketing materials.
- Evaluating prospects and choosing a buyer – (About 60-90 days) This stage starts with sending out fact sheets to prospective buyers. Once prospects have shown interest, they’re asked to sign a nondisclosure agreement (NDA). Next, potential buyers receive the CIM so they can research the company more fully. A series of in-person and/or virtual meetings follow, usually involving C-suite personnel of both companies. Next, prospects are invited to submit a nonbinding Letter of Intent (LOI), including their offer. After evaluating all the offers, the seller, their banker, and their M&A advisor will negotiate an LOI with one buyer, entering into an exclusivity period of 60 to 90 days.
- Due diligence and contracting – (About 60-90 days) The buyer and seller carry out their due financial diligence, as does the lender involved. They need to confirm that the combined company will have adequate cash flow to support the debt service of the purchase loan. The buyer's attorneys will do legal due diligence and draft key contracts, including the purchase agreement, any seller note or earnout, and employment agreements.
After these three stages have been completed, the deal moves to closing, which can be in person, virtually, or by a conference call.
Being ready for M&A
Every business should operate in ways that will optimize its value when the time to sell comes, even if that day is long in the future. Keeping financials clean, avoiding concentration risk, and focusing on growth are all smart ways to keep a business ready for sale. With good preparation and realistic timelines, buying or selling a business can be a positive opportunity for all parties involved.
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