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M&A: Securing the Best Possible Deal

By AICC Staff

March 12, 2020

width=300Over the past 30 or so years, I’ve been involved in a tremendous number of discussions about M&A deals, and I’m sad to report that many of the deals never actually close. The reasons for this generally come down to unreasonable expectations by either the potential buyer or seller or to raised by the buyer during due diligence that cause concern. In order for a deal to work, it must be a big win for both buyer and seller, and in order to make this happen, both sides need to understand what is motivating the other.

If you look at the economics of an acquisition from the buyer’s perspective, even a deal that is based upon a fairly pedestrian multiple of five times the expected cash flow that it will yield is difficult to finance because the largest portion of the purchase price is usually allocated to an intangible asset (“goodwill”). In the absence of some combination of synergies, economies of scale, or most importantly, integration benefits, there will not be any return on the investment for many years. A buyer needs something to enhance the cash flows that are being acquired above and beyond the cash flow that the target company is generating on its own in order to pay a high price. Sometimes the deal can be enhanced by geography or expertise that the target possesses, but the notion that a target company can be valued at 10 or 12 times cash flow or EBITDA based solely upon its existing business is not rooted in reality.

A buyer’s main concerns are its ability to keep the customer base together with continued growth and the ability to effectively manage the acquired business post-acquisition. Other concerns are the future investments required in terms of equipment systems and people, whether the culture of the target will fit in with their operating methodology, and the future commitments the buyer must make to get the deal done, such as long-term leases, employment contracts, and other legal or contractual obligations.

In order to maximize value, a seller must accomplish the following:

  • Prepare the company operationally, organizationally, and financially as far in advance as possible.
  • Have a good understanding of the value proposition that they will provide to a potential buyer, and don’t listen to all the noise surrounding this industry about other deals that have closed recently, of which they do not have direct knowledge.
  • Carefully consider and target the potential buyers who have the strongest strategic need to purchase them.

Preparation is probably the hardest part of this process from an operational, financial, and emotional perspective. Concerns about family, employees, lifestyle, and most importantly, long-term finances can be overwhelming. Most sellers have one chance to get this right, and the implications of making a bad decision can be irreparable and devastating, but very few really prepare themselves properly.

Let’s talk about operational and organizational concerns. No one wants to buy a company that doesn’t have a talented and motivated management team in place. Owner-operators that are overly involved in daily management, who control the largest portion of the sales, and who don’t possess the ability to delegate or share decision-making with others can be extremely problematic for a buyer. Once a decision has been made to prepare a company for sale, diversification of all of the key management functions takes on greater urgency. It is often difficult for an entrepreneur to deal with the emotions that go along with this aspect of preparing for a sale, but it can be the most important aspect of attracting the right buyer and securing the best possible deal.

Many closely held businesses blur the line between necessary business expenses and personal expenses. Family members are often on the books with no-show jobs or higher compensation levels than are appropriate. Personal-type expenses for cars, entertainment, and other items are run through the business. All of this necessitates significant normalization adjustments or add-backs to the company’s cash flow that is presented to a potential buyer. Similarly, the quality of the financial statements is often low. If you are serious about preparing for sale, then you should obtain audited or reviewed financial statements from reputable CPAs and try to minimize the number and magnitude of normalization adjustments that will be required to cast your business in the best possible light. Capital considerations must be made as early as possible, for a buyer will reduce the price for perceived capital investments that it must make to bring the operation up to standard. It is also important to note that every dollar of debt will reduce the net consideration that the sellers receive.

When deals are announced by large publicly traded companies, they generally report to the shareholders that the deal is based upon a fairly low multiple of economic value, something in the four to six range. Yet when the seller looks at the deal, he or she believes that a significantly higher multiple would be gained. How is this possible? The answer lies in the synergies and integration benefits that the deal creates for the buyer. If the buyer can shut down the seller’s plant and move the business to one or more of his existing facilities, millions of dollars of additional cash flow is created for the buyer. The same condition exists if the buyer can shut down one of his own facilities and move the business into the seller’s facility. Industry analysts have reported that paper mill EBITDA, when the paper is consumed domestically, can be in the $250- to $350-per-ton range, so the amount of paper consumed by the seller is often a significant component of the deal. In addition, profits to a corrugated sheet feeder on incremental business can be in the $5- to $10-per-MSF range. If a deal possesses the ability to give a buyer expense reductions, additional mill tonnage, and incremental sheet volume, then the buyer can afford to pay more. Most importantly, when you are valuing your company, you must take into account what the seller’s potential cash flows are from the deal and not just apply a high multiple to your existing cash flow. Understanding the economics of the deal to the seller is crucial to the buyer’s decision-making process.

For most closely held businesses, there is a certain finality to selling their business, and they must be prepared emotionally and have a sound financial plan going forward. The closely held business “piggy bank” will no longer be available, and all expenses must be paid for with after-tax dollars. The net proceeds received for the business must be invested wisely for the long term, and lifestyle choices must be made so that the funds will be preserved. In addition, no longer having a business to run and all that comes with it can leave a former business owner with too much unproductive time on his or her hands. It is critical to plan for these life-altering changes well in advance of the decision to prepare for sale.

Targeting the right buyer requires a good knowledge of the industry in which you operate and the players within it. Putting a book together and sending it to every prospective buyer can be extremely destructive to your business. Key employees and local competitors will soon find out about your plans and could cause a lot of trouble. The best approach is usually to target the buyers who have a real strategic need to buy you and who will have the largest potential for synergies and integration benefits. Confining access to your company’s information to a limited group of responsible, strategic buyers at a very high level of management is usually the best approach to maximizing value and minimizing potential problems associated with marketing your company.

My best advice for any of you who are considering a sale scenario is to start the process years in advance. Prepare your business operationally and financially, prepare yourself financially and emotionally, and make sure to target the right buyers in order to secure the best possible deal for you and your company.

width=150Mitch Klingher is a partner at Klingher Nadler LLP. He can be reached at 201-731-3025 or