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Letter of Intent 101: Everything You Need to Know

When private companies are sold, the parties often sign a letter of intent to ensure that they agree to basic terms. Negotiating this document can save time and avoid wasted effort. Here’s what you need to know.

What is Included in a Letter of Intent?

A letter of intent (LOI) typically includes:

  • Sale price
  • Adjustments to the purchase price based on whether the deal will be cash, seller financed, etc.
  • The structure of the transaction
  • Timeline for due diligence and negotiations
  • Escrow to secure the seller’s obligations and the length of time escrow will last
  • A timeline for the period of exclusivity
  • Details about access to key records so the buyer can undertake due diligence
  • Scope of significant representations and warranties
  • How third-party contracts and agreements with employees will be handled
  • Each party’s confidentiality obligations
  • How disputes will be handled
  • Under what circumstances the agreement may be terminated

LOIs can be long or short-form. Longer form are more comprehensive and legally detailed. They hammer out key deal terms well in advance, but demand a lot of upfront effort. Short-form LOIs are easier to negotiate and set general deal terms, but offer less protection against a deal falling through because of a fundamental disagreement over key deal terms.

What Type of LOI is Best?

A long-form LOI is typically best for the seller. This is because once the letter is signed, leverage in negotiations transfers to the buyer. The more terms a seller can iron out ahead of time, the better. Buyers are more likely to offer concessions in a competitive bidding process—before the LOI is signed.

The buyer’s perspective is exactly the opposite. Buyers generally seek a short-form LOI with a long period of exclusivity. In most deals, the parties must ultimately balance these competing demands.  

Binding or Non-Binding?

LOIs are not typically binding, or may be binding only for key provisions. In either scenario, the agreement must be clear about what is and is not binding. It’s common for terms such as confidentiality, deal exclusivity period, dispute resolution, and expenses to be binding.

An exclusivity period will be especially important to the buyer, since this gives the buyer time to undertake due diligence without fear that doing so might harm the deal.

Other Deal Terms

In addition to obvious factor like price, the LOI should also spell out other important terms, including:

  • Whether stock is part of the deal
  • The interest and principal payments associated with any promissory note
  • Whether there will be a working capital adjustment
  • Whether there will be an earnout, and what its terms will be
  • Dates by which key deal steps should be completed
  • The specific terms of any planned indemnification agreement
  • A full and thorough disclosure schedule
  • Conditions to closing
  • Agreements about an escrow or closing agent

Evaluating Your Company’s Weaknesses

The time you spend evaluating your company’s weaknesses is, as it turns out, one of the single best investments you can hope to make.  No one should understand your company better than you.  But to fully understand your company, it is essential that you invest the time to understand your company’s various strengths and weakness.

Your company, from the beginning, has been an investment.  It’s an investment in your time, your mental energy and, of course, your financial resources.  The time and effort you expend to locate, understand and then fix your businesses’ weaknesses is time very well spent.  Addressing and remedying your businesses’ weakness will not only pay dividends in the here and now, but will also help get your business ready to sell.  Let’s turn our attention to some of the key areas of weakness that can cause some buyers to look elsewhere.

An Industry in Decline

A declining market can serve as a major red flag for buyers.  You as a businessowner must be savvy enough to understand market situations and respond accordingly.

If you spot a troubling trend and realize that a major source of your revenue is declining or will decline, then you must branch out in new directions, offer new goods and/or services, find new customers and also find new ways to get your existing customers to buy more.  Taking these steps shows that your business is a vibrant and dynamic one.

You Face an Aging Workforce

It has been well publicized that young people, for example, are not entering the trades.  Many trades such as tool and die makers will be left with a substantial shortage of skilled workers as a result.  No doubt, technology will replace some, but not all, of these workers.

This is an example of how an aging workforce can impact the health and stability of a business.  If your business potentially relies upon an aging workforce then it is essential that you find a way to address this issue long before you put your business up for sale.

You Only Have, or Primarily Rely Upon a Single Product

Being a “one-trick pony” is never a good thing, even if that trick is exceptionally good.  Diversification increases the chances of stability and can even help you find new customers.  Additional goods and services allow you to weather unexpected storms such as a supply chain disruption while at the same time provide access to new customers and thus new revenue.

The Factor of Customer Concentration

Many buyers are concerned about customer concentration.  If your business has only one or two customers, then your business is highly vulnerable and almost every prospective buyer will realize this fact.  While it is an investment to find new customers, it is well worth the time and money.

A business broker can help you evaluate your company and, in the process, address its weaknesses.  Remedying your businesses weakness before you put your business up for sale and you will be rewarded.

Copyright: Business Brokerage Press, Inc.

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Why Debt Funds Are the New Industry Darling

With a booming M&A market, traditional investors have competed to get into the hottest PE funds, leading to record capital raises. Now institutional investors have set their sights on another opportunity: private credit funds.

Following the financial crisis, banks essentially shuttered their lending arms. Others trickled in to fill the void, with financial companies leading the way at first. Now all kinds of firms use private credit tactics. Though interest as risen for years, it reached a frenetic pitch in 2017. Fundraising soared more than 35%.

Big private equity firms such as KKR, Apollo, and The Blackstone Group have eagerly made their presence known in the space. After all, debt is in high demand among PE deal-makers. It offers solid returns, with few regulations. The debt market has exploded over the past eight or so years. When banks pulled back, it left skilled lending teams without a home. Many joined up with new financial institutions and started new lending arms.

Over the past few years, middle market private firms are showing an increased interest in private credit. H.I.G. Capital’s Whitehorse Capital, for instance, closed on $1.1 billion in direct investing 2017.

Businesses will always need loans. Institutional investors want in on these money-making opportunities. Gryphon Investors, middle market PE firm, closed its first fund, Gryphon Mezzanine Partners LP, with $100 million.

The big challenge here for PE firms is having potential competitors as creditors. The situation is volatile, and rapidly changing. Information leakage can be a problem, and debt and equity sides of the house must build Chinese walls that work well.

Insurance companies are also growing abundantly in the space. While some already have lending capabilities, many are growing their offerings. Manulife Financial Corp. expanded in 2017 to offer senior credit to the middle market. The insurance company.

Numerous insurance companies were active in mezzanine finance for years. These larger offerings are a natural extension of what they have done for a long time. It makes good financial and logistical sense. The big fear is that some of these new groups have not managed a fund through a financial crisis. Markets aren’t the same as what they were during the last financial crisis. So things feel different, but the next crisis will come. And it may be horrible. Many new lenders might not have the experience necessary to manage it.

With more debt available than ever before, markets just feel different. The parties at the highest risk are different, too, creating a false sense of security for some players. It’s no longer deposits and banks that are at risk. Now the risk rests with institutional investors in the lending market. They should be better able to assess and manage risk. But too much leverage is never wise. Adding more debt onto the pile of debt never lowers risk.

Some Driving Trends in M&A

The consumer goods space is humming with acquisitions over the last few years. There are no signs it will slow down, but it may change. Private-equity and mega-backed deals are increasing in number.

In addition to these players, we’re also seeing the role of shifting consumer desires. A strong interest in healthy, organic living is driving some conglomerates to really change their portfolio. This trend is likely to escalate over the next few years, as more and more consumers get on the health bandwagon.

Noteworthy Transactions
The May, 2018 acquisition by PepsiCo of Bare Foods Co. from PE firm NGEN Partners brought “healthy” carrot and banana chips under the Frito-Lay umbrella. PepsiCo previously acquired Off the Eaten Path, creator of Veggie Crisps.

The goal of many such mergers is to marry healthy living with an affordable price point and accessible products. The Honest Company, for instance, recently announced a $200 million strategic minority investment from PE firm L Catterton. Honest offers a brand that stands for something, but at a price point that’s accessible to a large number of consumers. We’re going to see more growth in businesses like Honest.

Risky Business for Larger Conglomerates
Organic and natural businesses may thrive when they’re small, but they don’t always do well under large conglomerates. Campbell’s presents a cautionary tale. It’s Campbell’s Fresh line has struggled following its 2012 acquisition of Bolthouse Farms and 2015 purchase of Garden Fresh Gourmet.

Distribution poses some unique challenges. The one-size-fits-all approach that works so well in prepackaged food is exactly what many health-conscious consumers with to avoid. Consumers may also be attracted to the unique messaging, small size, and independence of organic brands. They’re less drawn to large corporations. Large companies specialize in driving down costs and accelerating distribution. This is what consumers dislike about large companies, so it’s important to balance convenience with the mission of the original brand.

Effects on the Lower Middle Market
Companies in the lower middle market with “kitchen cook” owners, clean eating missions, and novel formulations are thriving. So too are personal care products with an earth-focused and health-driven mission. We’re witnessing an elusive breaking point where companies transition from home businesses to million-dollar-plus companies with penetration across multiple channels.

As with larger deals, integrity of the original brand is key. The found must remain present, and that means significant rollover equity and seller financing. This improves financial leverage, but it also maintains brand alignment and protects customer loyalty.

Larger brands are unlikely to reach down for smaller brands. This may be a good thing, since smaller companies must ensure the acquirer offers a good cultural fit. Family businesses are often a good starting point, since they have the flexibility to pursue smaller companies, and can generally preserve the integrity and story of the brand.

In this segment, as in all others, quality and price are key. The product must be better than something out there at a lower price point if it is going to thrive.

What Value Does an Investment Banker Add?

It’s the age old question that every investment banker must eventually answer: what value do you add? As with every other profession, investment bankers must justify themselves. If you’re selling a business, an investment banker is worth their weight in gold. They confer significant value, and can expedite the transaction while alleviating owner stress.

Yet many investment banking firms continue to advise that advisory is a dying art. They point to dedicated corporate teams that now shepherd the M&A process to perfection. They emphasize that these teams are often cheaper than outside advice. We don’t think investment banking is dead yet, or that it ever will be. Here’s what you need to know about this age-old art.

The Value of an Investment Banker

The process of selling a business involves much more than just finding a buyer and negotiating a price. The timeline from initial decision to closing ranges from weeks to months, and occasionally even years. You must negotiate all aspects of the deal, submit to due diligence, and ensure that the deal is a good fit for all parties.

That’s more than most owners can do on their own. Moreover, they will be working with a deal partner who may have significant experience at purchasing businesses, and who almost certainly has the benefit of a professional advisory team. That’s a decidedly lopsided equation. Owners go it alone—or use only in-house support—at their own peril.

Even assuming an owner can competently negotiate a deal on their own, there’s much to be lost. The demands of negotiating a deal are destined to distract an owner from the daily requirements of running the business. This can ultimately thwart operations and undermine value. In most cases, the cost of hiring an investment banker is far less than the money, profits, and time you stand to lose if you go it alone.

Why Your Advisor Must Justify Their Existence

The right M&A advisor confers significant value. That doesn’t mean you should hire the first person who comes knocking. The goal should be to find someone with deep industry connections to whom they can shop your business. You need a deal-making expert who can offer—and demonstrate—significant value. Put simply, your investment banker must be able to clearly explain why you need them. Some questions to get the conversation going include:

  • How many deals have you closed in the last three years, and at what value?
  • What is your specific plan for my business?
  • To whom do you hope to sell this business? What is your marketing plan?
  • What value do you bring to the table?
  • Can I speak to references?
  • What do you think is a reasonable value?
  • What specific tasks will you help with?

Finally, you must choose someone with whom you like working with. You’re not in the market for a best friend, but you will be spending significant time together. Ensure this is a person whom you can tolerate. Intuition and the right “fit” both matter.

 

Four Ways to Bring Significant Value to an Add-On Deal

Add-on acquisitions are more popular than ever, but they present a serious conundrum at integration. While deal partners may talk of synergies and cost savings, there may be little factual basis on which to identify what and whom to keep. Each company’s financials offer a good overview of operational capabilities, but many other tools offer better insight into integration and growth opportunities.

Add-ons have historically been used to promote inorganic growth, offering an immediate infusion of revenue to an existing platform company. In most cases, you’re purchasing intellectual property or market share that offer more cash and a chance to edge out competitors.

Here are four key areas that offer valuable growth from an add-on:

Know the Culture
When merging two different companies, you must know the corporate culture of each. Cultural fit issues are the most common reason mergers fail. It’s important to identify areas of cultural fit and shared values. Areas of possible difference are equally important to understand. The most successful mergers take the most appealing aspects of each company’s culture. Ideally, your staff’s lives should be better following the merger, and your customers should notice a positive shift in cultural change. A more restrictive working environment, fewer benefits, less pay, and a de-emphasis on customer needs are all cultural shifts that can add up to disaster.

Know the Brand
When you acquire a brand, you must have a clear understanding of the value it offers. This is doubly important if you anticipate a rebranding effort. Companies to often rebrand, only to find that the discarded brand had greater loyalty and more market penetration than the new brand they haphazardly implemented.

Know the Team
When you merge two different operations, you must determine who has the strongest and most compelling customer relationships before moving people around. The strongest players aren’t necessarily the most highly paid or respected. Instead, look at relationships and results, then plan accordingly.

Be Inclusive and Fair
The merger should make everyone’s life better, so if staff or customers feel you’re being unfair, you’re in for a rocky ride. The integration team should include vested, knowledgeable, committed players from both entities. The process should not be one size fits all. It’s equally important to recognize the value of diversity. The perspective of a single race or gender cannot possibly take into account all perspectives. You need people from a wide variety of backgrounds, or you’ll miss important information and make costly mistakes that lose you customers. Work toward consensus, not authoritarianism, in your change-management approach.

The Lower Middle Market: An Explosion of M&A Activity

The entire middle market is witnessing a flurry of M&A activity, with much of this activity concentrated in the lower middle market. Sellers are seeing strong markets with high valuations. Multiples are at an all-time high—often seven times EBITDA.

Understanding the M&A Explosion
Numerous factors have birthed the new, frenetic pace of M&A activity. There’s a lot of capital in the market right now. Lending markets have also added fuel to the fire, with debt multiples reaching 4.2 times EBITDA on the senior side, and 3.4 times EBITDA in lower middle markets. Buyers are now willing to over-equitize transactions. So lower middle market businesses with a decent story can get record high valuations.

Strategic acquirers also play a role in the surge. They’re moving down market in search of good deals. In many cases, they’re seeking add-ons for platform companies they’ve purchased at high valuations. About half of all global buyouts are add-ons. In the US, add-ons comprised 70% of first quarter buyout activity.

Creating Value in Today’s Marketing
The buy and build strategy is one of the most popular for creating value. But even long-term business owners can capitalize on this strategy by building their company into something valuable, or positioning themselves as either add-ons or platform acquisitions.

Just like with real estate, though, this bubble could burst. Even low-quality deals are getting bid up to high rates. So when there’s a downturn, high quality assets will survive. Lower quality ones will struggle. If buyers aren’t able to grow their assets, their could be a nasty downturn.

When Will the Tide Turn?
While owners are loving the boom, buyers hope that things will stabilize. The market is competitive. Everyone is seeking to buy, and buyers must remain disciplined. This may mean passing on companies because the price is just so high. With larger funds so well capitalized, smaller buyers just can’t compete.

Most analysts see little indication that the tide will soon turn. The traditional signs of a slow-down are absent—which is good news for owners. While the growth of private lending in the lower middle market would traditionally be a red flag, there’s little reason to believe things won’t continue the way they have. There’s no underlying reason for them to stop. Of course, the economy operates according to boom and bust cycles, so it must end soon. We just don’t know when—or why, or how.

The rule has always been that, when lower middle market companies meet a certain benchmark, their multiples go up. The increase today is more significant. Buyers are purchasing smaller and smaller businesses and merging them together. This can mean increasing value from 5-6 times EBITDA to as much as 10 times EBITDA. Sellers love it. Small buyers hate it. And this leaves analysts to look at the big picture—what will happen next? What about the low quality businesses that will eventually tank? A change is coming, but it could be years away.

Search Funds: A New Option for Entrepreneurs

The Baby Boomer retirement boom is coming. In 2017, 36% of small business owners said they planned to change ownership in the next five years. Though traditional acquirers are eager to purchase these businesses, there’s a third option available: search funds. As a new generation of talented entrepreneurs graduate from elite business schools, many new graduates want to be Main Street CEOs instead of heading to Wall Street. So they’re eager to acquire small businesses.

One increasingly popular way for them to accomplish this end is via search funds. A decade or two ago, this was a strategy virtually no one was trying, and almost no one had even heard of. Now, they’re all the rage in business schools, with some MBA programs even creating search fund-specific programs. This strategy shows no sign of declining in popularity, and stakeholders on all sides of the M&A equation need to be aware of the increasing influence of search funds.

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So could a search fund be an option for fueling entrepreneurship? Here’s what you need to know about this option.

Search Fund Models
Search funds come in three basic forms: self-funded, traditional, and fundless sponsors. Traditional funds allow searchers to raise capital from an investor group seeking a company with specific agreed-to assets. Investors have the right of first refusal on deals the searcher finds.

Self-funded searchers finance their search efforts. When they find a deal, they then seek outside capital. Terms are negotiated for each deal, and deals are often funded via SBA loans.

Fundless sponsors raise capital from either a single source or an investor group. Fundless sponsors tend to be more experienced. They are knowledgeable at deal structure, and people often choose to back them based on prior experience.

Search Fund Education
As search funds become more popular, more programs are being created at business schools. Many students view search funds as less risky forms of entrepreneurship. They allow students to buy from retired founders, and to purchase businesses that are already tested. Students view this as inherently less risky. A combination of increased awareness, a willingness to experiment, and economic forces—such as retiring Baby Boomers—have increased student interest in these funds, and spurred business schools’ willingness to educate about them.

Will the Search Fund Trend Continue?
Search funds may seem like the latest and greatest trend. Most analysts think this trend will continue. The timing is right, and more business schools are educating and raising awareness about search funds. But the forces that drive search funds of the future may be quite different from those that have driven the current trend.

More business school graduates see older peers doing search funds at a large volume. On average, the results are good. That drives interest. There’s plenty of money out there to support a growth of search funds. With private equity returns diminishing, entrepreneurs are looking for higher returns. They’re turning to search funds to deliver on the promise of higher returns.

Doing is the Best Kind of Thinking

tom-chi-eventOne of the most significant reasons why Tom Chi was able to invent Google Glass, self-driving cars, Project Loon, and hundreds of game-changing inventions so fast is this…Tom learns fast and tries oftenmaking small variations until he succeeds

What could our generous community of leaders accomplish – individually and collectively – if we become masters of staging and testing new ideas, learning rapidly, and increasing how many new things we try?

Anything is possible, and we invite you to click the image to the right and dig deeper to discover what prototype thinking can do for you!

How to Keep Employees Engaged During An Ownership Transition

Ensuring that your employees stay on course during your ownership transition should be one of your key areas of focus. There are many key steps that you should take during this delicate time. Let’s explore the best tips for keeping your employees engaged throughout the entire ownership transition process.

Group of confident managers listening to female employeeStep 1 – Establish and Implement a Training Program Early On

If you are selling your business, then be certain that you train replacements early on in the process. Failure to do so can result in significant disruptions. Additionally, if you are buying a business it is of paramount importance that you are 100% confident that there are competent people staying on board after the sale.

Step 2 – Address Employee Concerns

No matter what your employees say or how they act, you must assume that they are worried about the future. After all, if you were them wouldn’t you be concerned at the prospect of a sale? The best way to address these concerns is to meet with employees in small groups and discuss their concerns.

Step 3 – Don’t Make Drastic Changes

Above all else, you want a smooth and fluid transition period. A key way to ensure that this time is as trouble-free as possible is to refrain from making any drastic changes before or after the transition. Remember the sale of the business is, in and of itself, shocking enough.

You don’t want to add yet more disruption into the process by making changes that could be confusing or unsettling. In other words, keep the waters as calm as possible. Drastic changes could lead to employees quitting or worst of all, going to work for a competitor.

Step 4 – Focus on the Benefits

If possible focus on the benefits to your employees. It is your job as the new business owner to outline how the sale will benefit everyone. Don’t let your employees’ imaginations run wild with speculation. Unfortunately, this is exactly what happens when employees and management feel as though they are not receiving any information about the sale. So don’t be mysterious or cryptic. Instead provide your employees with information, and keep the focus on how the changes will benefit them both personally and professionally.

Implementing these four steps will go a very long way towards helping to ensure a smooth transition period. Transition periods can be handled adeptly; it just takes preparation and patience.