I feel like there is a huge misconception about the timeline of M&A transactions and the functions carried out by affiliated parties during the process.
Private Equity M&A Process Timeline
Therefore, I would like to assume the following scenario in order to illustrate the entire process: A private equity funds (“the seller”) seeks to exit an investment in one of its portfolio companies.
Hiring an Investment Bank & Contacting Potential Buyers
First, an investment bank is hired to screen potential buyers. After identifying potential buyers, the investment bank will distribute a short teaser about the portfolio company’s performance and outlook to all potential buyers. A confidentiality agreement (CA) or non- disclosure agreement (NDA) will be enclosed to the teaser , regulating the level of disclosure in order to prevent leakage.
After giving the potential buyers some time to review the teaser, the investment bank will catch up and measure the potential buyer’s interest to advance in the process. The investment bank will then distribute an investment memorandum (IM) (I believe most of my fellow monkeys know this as pitch book) to a selection of potential buyers that show interest in pursuing a transaction with the portfolio company.
Drafting an Investment Memorandum
The IM normally includes the portfolio company’s strategic development, macroeconomic overview, industry overview, company overview (organizational structure, ownership), sales and production strategy (including distribution channels) and of course financial information. Although the information for the IM comes from the seller, the investment bank is responsible for compiling and presenting the data. This process could take up to three months and is the reasons that a short teaser has been distributed before.
Non-Binding Bid for Target Company
In order to signal serious interest in a transaction, the potential buyers have to make a non-binding bid subsequent to the review of the IM. The seller herby wants to make sure that only qualified and serious parties enter the data room for further due diligence. You don’t want to give away secret company data to a competitor! However, investment banks try to keep as many potential buyers as possible in order to increase competition and the final consideration.
Virtual Data Room and Due Diligence
After making a non binding bid, the remaining bidders are granted access to the virtual data room, which includes undisclosed data. Usually the potential buyers hires financial advisors to conduct financial, legal and tax due diligence. Financial advisors (for the financial part) are the transaction advisory arms of auditing firm, boutique investment banks (Which offer both investment banking and advisory services). Legal and tax advisors are lawyers and tax auditors.
Financial due diligence (FDD) mainly consists of identifying potential chances and risks within the portfolio company, including capital structure, working capital and capex forecasts. Additionally the portfolio company’s business plan and forecasts on financial ratios will be review. Another important part of the FDD is to normalize EBITDA, EBIT by adjusting reported numbers for unusual events (for example divesture of a subsidiary) The adjusted number will be reported to the investment bank and will most likely be used for the valuation. (Or not)
Valuation and Bid Values
Although the seller’s investment bank will give some insight about the portfolio company’s valuation during the entire process, it is up to the potential buyer how much he wants to bid. The portfolio company’s valuation is made by the buyer’s corporate development department/in-house M&A team or by another investment bank (or financial advisor) that has been hired from the buyer along the process.
How IBanks Value Companies?
As explained in many other blogs before, a valuation of private equity/ M&A transaction (LBO transactions are little bit different) is mainly based on comparables. You calculate various multiples (FV/revenues, FV/EBITDA, FV/EBIT, FV/EBITDAR, FV/traffic on website..) for the peer group (or precedent transactions) and calculate the portfolio company’s FV by plugging in the multiples of your peer group (average, median, or min/max) into the formula, using your financial data (EBITDA according to financial DD)
In order to back up their “market” valuation, investment banks also calculate a firm value according to DCF (PE’s use exit multiples instead of TV). The DCF valuation should equal the market valuation (based on multiples) or should be higher in order to leave some upside. In order to get the portfolio company’s equity value, subtract net debt, preferred stock, minority interest and add back investments in unconsolidated entities. This should only happen if those numbers have been included in the FV calculation for the peer group of course. (This is worth another blog actually)
Management Meetings for Buyers
During the entire process, meetings will be held in order to make the current owner and management familiar with potential buyers and to pitch them the current due diligence results and valuation. Along to the meetings with the current owner and management, a lot of numbers regarding the portfolio company’s valuation will be pushed back and forth between investment bank, potential buyer, seller and financial advisors. There will be an active discussion about which positions have to be included into EBITDA (or any other valuation metrics), thus impacting the total consideration.
Share Purchase Agreement and Deal Closure
In case one potential buyer and the seller come to an agreement, both parties sign the SPA (Share Purchase Agreement) . I could write at least 2 more blogs, explaining the most important points in an SPA. But let’s just drop some key words. The spa usually includes arrangements regarding final consideration, affiliated parties, antitrust issues, macro- clause, locked box vs. completion accounts (silver bananas for monkeys outside PE how know what that means)
After the SPA is signed and the deal is closed, financial advisors (again transaction advisory arms of auditing firm) have to test the portfolio company’s assets on impairment and allocate the purchase price (PPA) . In that way, the value of goodwill (if existing) and other intangible assets can be identified and booked according to IFRS.
As you can see, there are a lot of parties involved in an M&A process. I would like to hear from my fellow monkeys if they agree on that timeline and would appreciate any additions/corrections. Please also let me know if you want me to elaborate on a specific event during an M&A process.
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Thanks for the post. Under a completion account approach, the price the buyer pays can vary based on actual vs. forecast profits or cash flows. With a locked box approach, the price is final and not subject to change based of future cash flows or earnings, which frees up time but adds more risk for the buyer. Am I completely off here?
Great post
Great post, only thing I would add would be proceeds analysis / waterfall modeling that the sellside advisor (analyst's responsibility) will do after getting second round or more final bids. This will show how all shareholders will be paid out at different bid prices based on the company's current cap structure.
Anyone else notice how buy-side consultants will make it sound like the "sky is falling" on your sell-side client in order to justify their crazy fees? Kind of reminds me of those corporate ambulance chaser lawyers who drop post-acquisition lawsuits on public companies, saying the ridiculously high multiple it sold for was "not in the shareholders best interests.."
Thanks for the post. One thing I was looking for was maybe a "top 5 deal killers" whether it be reps/warranties/caps/baskets etc.. but that's a whole separate (and far less interesting) blog topic.
Summary: Pitch Investment Bank - Engagement Letter / Teaser - Initial Interest / Confidential Agreement - CIM / Pitch Book - Initial Bid - Mgmt Presentation - Due diligence / data room - Final Bid / Definitive Agreement
Here is where I disagree with the OP. The pitchbook comes in the "pitch" step, i.e. step #1. The banker has to pitch himself and his team to you, so he puts together a pitchbook selling why his firm is the best to do this deal. Once an engagement letter is signed, then he's past the pitchbook stage and working on a deal.
He is referring to the management presentation that is used for meetings with potential buyers.
How long is the M&A process? (Originally Posted: 05/13/2010)
Hey guys,
Often times when a deal is announced, the press release mentions that the deal is "expected to close in a few months." For bankers, after an agreement is reached on the purchase, do they still have responsibilities and assignments on the deal, or is it left to the lawyers, company management, and shareholders to deal with?
Thanks,
Jack
Just a quick question on the FDD part, do buyers usually hire the advisory arm of an auditing firms for it? Or do the investment banks representing the buyers will provide such service as well
Still have responsibilities, but they are minimum compared to before. Most of the due diligence is done by the lawyers and management (also can be affected by regulators if cross-border or possible monopolistic iissues), but bankers occasionally have to join in or assist management depending on whether they are advising the sellside or buyside. If you do a fairness opinion there may be additional work as well. Basically at the junior level though once announcement occurs there is very little to do except the occasionally news run update.
Thanks keyboardcat. That was very informative. Is it usually the buyside advisors that are likely to assist management in those situations, or sellside as well?
The M&A process generally runs as follows: 1) Company decides or banker convinces company that an M&A event is in the Cos best interest 2) If the former, company runs a beauty pageant and each bank pitches its services ("look, we are at the top of the league table for industrial companies in the south-western part of Utah with market caps between 200 - 435 MM, choose us") 3) Company chooses a bank, sell-side bank compiles company data and begins building the offering memorandum ("OM" or "CIM") 4) Bank contacts potential bidders (strategics and financial sponsors "PE") 5) Sell-side bank sets up a data room and interested bidders do diligence using the advisory services provided by lawyers, buy-side bankers, consultants, etc. 6) Interest bidders submit round 1 bids 7) top 3 - 5 bids go through to next round 8) Bidders meet with management team and sell-side bank and do more in depth due diligence (quality of earnings, etc.) 9) Final bids are due (sometimes 1 more round) and a winner is chosen. Winner is chosen based on certainty of close, valuation, form of payment currency - cash, stock, combo 10) Deal announced - buyside bankers continue to work with purchaser, lawyers, accountants to finalize the deal and get final documents executed
Do banks lower their fees in an attempt to win business? If so, is there some sort of unspoken agreement between the various banks not to lower their fees beyond a certain point?
Hi,
Thanks for the comment. Do you also have a view on how the transaction advisory firms get the clients (engaging buy-side parties)?
Thanks
"Do banks lower their fees in an attempt to win business? Yes
"If so, is there some sort of unspoken agreement between the various banks not to lower their fees beyond a certain point?"
No, it's up to each bank, the MD, the management committee how low the fees can/will go. It's all about relationship between company and bank. Some ibanks will lower fees if they can get a bigger piece of the following debt offering / acquisitions facility, etc. There's tons of fancy footwork going on, and it's usually decided between the MD on the deal and CFO at the company.
Usually the big 4 will do the FDD Also just add on that in parallel with FDD and LDD, we hire external consultant (MBB + LEK in some cases) to do a thorough market study (target, competitor, trend etc) to validate our investment thesis. This is usually called Commercial Due Dilligence (CDD). Your internal investment memo (for your investment committee to read) will contain a large chunk
Walk me through an M&A process... - thoughts, advice, where are the tricky things? (Originally Posted: 08/12/2015)
Hey guys,
I am new in IB and now interviewing for M&A roles and have been experiencing the "Walk me through an M&A process" question. I feel a bit uncomfortable with this question and would really appreciate your thoughts and advice to answer this question that I think is not as easy as it appears.
Many thanks
Why does your profile indicate a 2nd year M&A analyst if you're new to IB and don't know how an M&A process works?
http://www.dummies.com/how-to/content/steps-of-the-ma-process.html
No offense intended by the website name, it just happened to come up as one of the first Google search terms. What a coincidence though...
Great post. +1
Great post; thank you for sharing.
great post, thanks!
I'd add that I've seen an increased use of earnouts, which help spread the risk in a deal. Acquired cos. must meet performance goals i.e. : Net Revenues/Income, Gross Margin, Pretax Profit, EBITDA, or other milestones (e.g. new product, drug approved by the FDA /in pipelines).
Yes, I agree on that. I have seen many earnouts that are structured as put/call options. The ratios you mentioned are used as strike prices.
CIM
awesome post
Great post! One comment, after the non-binding loi there may be an incentive to keep as many buyers as possible... but you can also choose to go with only one (or 2), most serious offers and logical buyers into an exclusive process and speed things up versus continuing with the full auction process.
Sorry for all the questions but I want to get this down:
Is there any regularity to fairness opinions on M&A transactions? Could you give a context to when they would be applicable?
And you write that there will be a lot of "back and forth between investment bank, potential buyer, seller and financial advisors" but isn't an Investment Bank involved in M&A always considered a "financial advisor" anyway?
Appreciate the help.
I generally recommend getting an FA from a third party.
I'm not sure what is that you're asking, but you need to be licensed (series 79) to be involved in the M&A process.
Obviously it varies to some degree, but can anyone provide a rough estimate of how long the entire process takes, from the bankers' hiring to the announcement of the sale and consideration? Thanks in advance.
Thanks for the post.
Can you share, if known, how the transaction services firms (except for the Big 4) who provide financial due diligence services reach the potential buyers? Is it also pitching, actively screening for potential deals and reaching the potential clients in advance of the deals?
That would be very appreciated.
Thanks
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