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[A brief note. M&A transactions often involve a substantial amount of regulatory, legal and taxation considerations and, as such, legal and tax professionals should be consulted for in-depth explanations any specifics in these areas. Although the following article may make mention of legal documentation or taxation elements, it is to present types of documents that one may expect as this process is initiated. The specific area of consulting expertise is in areas of corporate finance, valuations and operations.]
written by : William F Bryant
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Areas of Interest
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Financial Analysis
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This step is all encompassing, and I mean all encompassing. This step can be so involved and require many hours of work, relative to the overall transaction, that it is often separated into a preliminary and a deep-dive of the target firm’s information. Of course, this isn’t always the case. It is, however, important to understand the lengths to which a gathering of information can go and the potential material investment when considering this path as a strategic buyer/seller, or even a financial buyer/seller.
Information. It’s a vague term and in the case of due diligence and information gathering it can cover anything and everything that may have an impact on the firm. Impacting details can be found in detailed lists of PPE, inventories, suppliers, customers, new products and intellectual property, operational licenses, environmental issues and any litigation in the past or future. As you can see financial statements don’t even begin to cover this phase of document gathering and it can even extend to firm management and any issues that management may have had in their lives, from DWIs to bankruptcies, as they reflect upon the team that dictates operations of the firm. Some might call this stage invasive, especially if you’ve never gone through an M&A transaction, but the entire corresponding structure of the deal comes from the due diligence phases. The valuation, financing and even the strategically determined corporate structure can all be determined from the information gathered in the due diligence phase. Due Diligence drives conditions for closing, covenants, indemnifications and representations and warranties that guide MAC/MAE. (MAC/MAE - Material Adverse Change / Material Adverse Effects are outside the scope of this article and include a great deal of M&A legal vernacular that is best addressed by a M&A legal specialist. In very simplified terms, these are events that would qualify a nullification of the deal at the last stage, for the acquirer, which has proven all but impossible in a court of law . For an acquirer to show a material change, substantial evidence must be present and material is a vague term. If you would like more reading into a situation that a MAC has occurred you could inquire as to the acquisition involving Tyson Foods and IBP inc.) Specifically, the areas where a consultant with a M.Sc. Finance and an MBA would be of value are the areas of external valuations and modeling thanks to in depth education of corporate finance with the M.Sc., as well as, the internal valuations of operations thanks to the educational focus of the MBA. |
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Valuation methods, with substantially more depth, will be covered in the next article and so I will comment only on the internal segments of the firm that will utilize the financial accounting statements, managerial accounting statements and operations analysis.
Whether the acquirer or the target, the consultancy would involve a study into these areas: A) Quality of Assets Target Working Capital, Investment in Operation Capital Analysis of Fixed Asset/CapEx/Inventory Throughput, Capacities, Supply Chain B) Liabilities AP & Accrual analysis, Off Balance Sheet items, Lease Analysis (Recent GAAP Change) Contingencies, Commitments Leverage, Target Capital Structure C) Quality of Earnings Normalized EBITDA, Analysis of Revenue/Margins/Expense FCF, Cash Conversion Cycle D) Projections Reasonability of Assumptions, Sensitivity Analysis, Market Analysis, Probability Distributions, Monte Carlo, ARIMA Model Development and Model Integrity Accounting Policies, Metrics, Ratios, Synergies The areas are the prime drivers of the deal. This evaluation determines, the price paid, how the offer is structured and corresponding taxation, in addition to whether the deal may be profitable and productive into the future. In short, these areas determine value. If you work or have dealt with any case studies in economics then you realize just how encapsulating the term value can be in the context of an acquisition and why it may be a good choice for external consultation. The advantage of an external consultation avoids a number of possible pitfalls including, not least of which are, job-security distractions. External consultation can help to customize a due-diligence list, fills gaps in team coverage, add to the knowledge of what is relevant information is and furthering business understanding for an acquirer. In addition, the early stages can benefit from an outside look to prepare a determination synopsis before a deeper commitment decision is made. As you will note, the teams grow as a deal progresses. You might be wondering what happens if your target or the acquirer is a competitor; a firm may have significant intellectual property and research and development underway that would impact future competition. This is where your legal consultant steps up with a confidentiality agreement before the preliminary stage of the due diligence is underway. Confidentiality agreements are initially structured by the targets and include legalese on topics of protections for intellectual property, directions for disposal of intellectual property documents, non-solicitation of employees, standstills, period of enforcement and no obligation to deal to name a few items. Contract structure and wording is extremely important throughout this process so be thorough and direct with intent as you and your legal advisors compose any legally enforceable and binding agreements. If you happen to be the target, know that you too will conduct due diligence on the acquiring firm to ensure, not least of which, the ability to complete the transaction. With the NDA out of the way, and commitment made, the early stage team gets into the preliminaries. Finance professionals, accountants, IT consultants, engineers, human resources professionals, real estate appraisers and industry specific advisors may all be apart of the diligence team and work to determine, principally, if a deal should proceed. The deal and structure will all be relative to negotiated terms, reps and warranties, covenants and capital structure. Throughout the due diligence gathering, it is in the best interest of the target firm to begin to accumulate data in a single, organized location. Data accumulation is done in a Data Room, which can be a physical room or an accessible, possibly internal or external data application. A central location should not only store the information in an organized method, but it should also offer levels of accessibility to acquirers that are interested in the target firm and the ability to continually add more information. While a physical, on-site Data Room may be applicable in some scenarios, most opt for an application that offers flexibility of access and methods that determine how information may be viewed, whether printable, emailed or even what terminals have access. One such application, that was suggested by Rosenbaum and Pearl’s Investment Banking* is Intra-links, however a tech department may be able to structure a data app . Given that the accessibility and storage of data is integral to the essential process of due diligence, consideration of how a firm is comfortable sharing information is worth the time. * Rosenbaum, J. & Pearl J. (2013) Investment Banking: Valuation, Leveraged Buyouts and Mergers & Acquisitions (2nd Ed.) Wiley. The due diligence and information gathering process is obviously important to an M&A transaction. An information gathering process always begins with organizing a list for what information is desired and a method, hopefully interactive, for storing the information when received, the Data Room. This checklist does not have to be a colorful marketing-designed list, it is not part of the presentation package. It does have to be thorough in questions involving the firm, firm outlook, management, operations, industry and industry outlook to ensure that everything needed to structure a fully informed deal has been gathered. It is from a list that a team will ensure that questions, answers and delivery of documentation have been asked, received and are trackable to all involved on the team. |