Tools, tips & tricks for company transactions.

Tools  
   

 

  • Due Diligence Checklist [40 Pages | DE/EN/PL | PDF | 500 KB]
    Deutsch (DE) 
    Dreisprachige Checkliste, die einen Überblick über mögliche bei einem Unternehmenskauf bzw. Unternehmensverkauf relevanten Daten gibt.
    Englisch (EN) Checklist of possible relevant information during a company buy or company sale process in three languages.
    Polski (PL) Trójjęzyczny lista kontrolna, która daje przegląd możliwe istotne w zakup firmy lub danych o sprzedaży firmy.

 

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A brief foray into the language of corporate transactions

In Germany many areas of life are saturated with English words. To ensure reliable communications, a good grasp of English terminology above and beyond everyday English is often necessary. This is particularly true of industries with a global reach such as IT and finance. English jargon and cadence quickly become second nature. A conversation with a person to whom such jargon is alien is all it takes to make you realize how pervasive such terminology has become. What‘s the German word for that again? How can I circumscribe that?

As an M&A advisor - sorry: As an advisor for corporate transactions (M&A = mergers & acquisitions) you face an investor, together with your client, for whom M&A is routine business. In order for the deal (transaction) to go through, information has to be communicated correctly in talks. Both the terms and the contents must be understood. Creative financial solutions and legal aspects can be particular obstacles. Yet, before matters have even progressed this far, lots of jargon will already have come into play.

At the very beginning of the M&A process, there will be a so-called beauty contest or pitch. The beauty contest involves the M&A advisor endeavouring to sell his personality and skills. Once the M&A advisor has been granted a sell side mandate or perhaps a buy side mandate to identify potential takeover candidates (targets), he first creates an information memorandum as part of the sales process. This document provides a full description of the company for the potential purchaser and includes information about the business model, market, competitors, products, organisation and medium-term planning (business plan). In addition, an indicative valuation of the target is carried out. Based on the selection of potential buyers a so-called long list is created. Together with the client, the M&A advisor then whittles the long list down to a short list of potential buyers to whom a marketing approach will be made.

Once the potential buyer has demonstrated genuine interest, following signing of a confidentiality agreement or NDA (non-disclosure agreement), he receives the information memorandum. The most interesting potential buyers, as determined by the seller and the advisor, are then asked to provide an LOI (letter of intent) or non-binding offer. Sometimes the company in question is sold via a bidding or auction process.

Of central importance in the sales process is the enterprise value, a simplified means of ascertaining an appropriate asking price. The enterprise value involves talk of multiples which typically are applied to the EBIT (earnings before interest and taxes) to arrive at an approximate value. These multiples are derived from historic, industry-specific values and the size of the company. Naturally, there are other means of determining the enterprise value. Both in the offers and later in the contracts, a number of other specific parameters aside from the sale price are included. Due to space constraints, only a few of the more common terms are mentioned here.

Financial constructs in particular are peppered with English terminology. To cover any deviations in values between negotiations and closing, a typical method is the locked box mechanism or purchase price adjustments. The latter is the reconciliation of assets with regard to their value during negotiations and at the closing of the transaction. The locked box mechanism lends itself to this process as it often entails considerable work (e.g. an interim statement). It is therefore contractually agreed that as of the locked box date no funds, etc. can be leaked.

Often a part of the purchase price is paid at a later date. Deferred compensation refers to the payment after a certain period following fulfilment of the contract. An earn-out is a contractual provision allowing the seller of a business to obtain additional compensation in the future if the business achieves certain financial goals (those promised in the business plan). When required, an escrow account is drawn upon to cover any guarantee claims. 

You often hear talk of NewCo‘s - a new (proposed) company in which the target starts up after the successful takeover. The type of deal is also important. There are share deals, whereby shares in the company are acquired, and asset deals whereby selected parts of or assets in the company are purchased.

Before the final takeover, several steps must be taken. A small number of potential buyers are given the opportunity to carry out due diligence, i.e. a thorough assessment of the target’s finances, tax and legal situation, technology and market. The assessment takes place in a so-called data room, an actual or virtual room in which all relevant documents are stored. Following due diligence potential buyers are asked to deliver a binding offer. Negotiations are then held exclusively with the most attractive potential buyer. Once the buyer and seller have agreed on a final sale and purchase agreement, a signing or closing takes place. This means that the sale and purchase agreement is signed and the transaction has been closed.

As this short summary of the transaction process shows, the amount of English used in M&A in Germany (and surely in other countries and languages) is enormous. Whole books could be filled with these terms. It is therefore all the more important that these terms are fully understood. A good M&A advisor is fluent in M&A-speak and can translate it perfectly. If not, it will all be Double Dutch to him.

As everywhere in our economy, the success of M & A sales process is based on supply and demand. A structured and systematic approach for a company sale is the most important part. This includes a thorough analysis, careful research and an attractive information memorandum. In the following, we outline the project schedule of a professional company sale.

Read more: Structured Process of a Company Sale

Company transactions are often characterised by disputes about the sale price. The buyer has a critical view of the seller’s optimistic planning. The seller, on the other hand, sees the buyer’s interest in risk aspects as an attempt to drive the purchase price down. It is precisely this point that often leads to failure in negotiations of company acquisitions and sales. Easily, the discussions could have been shortened with the agreement on an earn-out clause that is fair to both sides.

The earn-out clause formulates additional price or guarantee agreements that include the reduction or indeed the increase of the purchase price if the actual development subsequent to the transaction is different from that planned. For example, a basic purchase price is agreed. Should the planned results be achieved or even exceeded, then additional and variable elements of the purchase price will be paid. The overall purchase price is thus understood as the cash value of all payments flowing to the company’s seller over a defined period.

There are obvious advantages to the earn-out clause for both purchaser and vendor:

The buyer gains security and pays the higher purchase price only if the target values are actually achieved.
The buyer not only improves his security; he also benefits from a financing effect which can be considerable. The sums exceeding the basic purchase price are not payable immediately. The payment extends over the agreed period and is mostly carried out in multiple tranches.
The company’s positive development often means that the vendor benefits from a higher purchase price than expected in the first place. However, the seller should ensure that he can monitor or maintain influence over the business and accounting policies during the complete transition phase.

A Strategic Competitive Advantage in Business Financing?

As a consultancy business in the field of mergers & acquisitions as well as corporate finance, we are privileged to get to know a broad spectrum of companies very “intimately” in a very short period of time while working on projects together.

During these projects, in almost all cases, questions sooner or later arise about the unique selling proposition (“USP”) as well as disadvantages, all of which are worth identifying. Normally, a company’s special market positioning, its range of products and individual know-how differentiate it from the competition. In recent times, however, competitiveness has received increased attention in terms of ranking a company, and this has in the last few months taken on the highest importance – in the ongoing assessment of company financing. A sometimes painful reassessment has taken place against the background of the global financial crisis.

To word this in a relatively gentle way, the best company concept, the most innovative products, the best operations and marketing strategies are worthless unless these are backed up by an ongoing capital strategy.

Limitations of traditional corporate financing

Traditional SME corporate financing has always consisted of a combination of the company’s own capital and external capital from the bank, such as in the form of loans or current account credit lines. The possibility of expanding financing by external means is thus relatively restricted, not least by bank-specific requirements (Basel II etc.), which are primarily dependent on the company’s own paid in capital.

It is thus clear that sufficient paid in capital is vital to long-term company success. “Where can you get it unless you steal it” means either one or the other - the possibilities for generating organic additional paid in capital through retained capital earnings are limited. Even holding companies have found themselves rather “straitjacketed” in the last few months because of their limited possibilities for refinancing. To the vast majority of small and medium sized companies, the stock exchange as the classical way for generating paid in capital is neither possible nor sensible.

Private Placement – Principles and Concept

Against this background, private placement has in recent times experienced a renaissance. There is no general definition for the term Private Placement in German. The English term Private Placement is therefore normally used when a company chooses to finance itself directly on the non-listed capital market using paid in capital or financial instruments similar to paid in capital.

Private placement is based on the principle that the company itself places securities or non-security-backed productive investments in itself on the open capital market. Depending on the size and complexity of the “assembled capital package”, the issue can be performed by the company itself, by investment banks, financial services traders or directly to SMEs with the help of respectable consultancies.

Because of its widely disparate range of players (including private persons, companies, institutional investors, funds, holding companies, etc.), the open capital market and its products are at first sight relatively confusing, and the market is thus often called the “grey market” by varying numbers of authoritative sources.

It is however worth remembering at this point that bodies such as banks holding investment certificates or their own fixed-interest securities etc. often refinance using this allegedly “grey” market segment. Holding companies and investment funds also require refinancing, and normally use various means of private placement to do so.

What could be more obvious, at a time in which banks and other traditional sources of financing for corporate financing have “failed”, than to get in direct touch with financiers as part of a private placement? Businesses in the renewable energy sector are already well aware since a very early period that private placement is an efficient means of procuring capital.

Nor should the open capital market be seen as a legal free-for-all. A series of relevant laws and supplementary legislation ensure clear rules for the protection of all involved. For example, the issue prospectuses necessary for any large-size issue must be submitted for approval by Germany’s Federal Financial Supervisory Authority (FFSA).

Financing instruments in the context of private placement

The products available on the open capital market are as wide-ranging as its players. There are basically three capital classes available as financing instruments as part of a private placement:

1) Paid in capital e. g. in the form of
a. Shares
b. Limited partners’ participation

2) Mezzanine capital e. g. in the form of
a. Fixed participation
b. Participation rights
c. Subordinated bonds / loans

3) External capital e. g. in the form of
a. Loans
b. Notes.

Selecting the appropriate financing instrument for the company is dependent on a range of influential decision criteria:

- The influence of the capital provider on the company
- The duration of time during which the enlisted capital is retained in the business
- Information provision requirements to investors
- Type of interest (profit-dependent, fixed, mixed)
- Profit and loss participation
- Effect of the balance, such as on the paid in capital ratio
- Convertibility of external capital to paid in capital
- etc.

Against this background, it is not unusual to combine different financing instruments as part of a private placement.

Planning and implementation

A private placement should generally be preceded by a thorough, professionally-performed planning process, the detailed implementation of which must clearly follow the structure of this planning.

The elements of the preparatory phase may include:

- Development of a long-term capital strategy for the company
- Selection of appropriate financing instruments
- Definition of issue volume
- Planning of the stock division
- Selection of target investor groups
- Selection of sales routes (own sales, investment banks, financial services providers, consultancy, etc.)
- Marketing measures (road shows, online marketing, etc.)
- etc.

Depending on the volume, target groups and the number of respective target investors, it may be necessary to draft a socalled issue prospectus, which must be approved by the FFSA prior to publication. The format and content of the prospectus are subject to certain legal requirements, and it will normally make sense to delegate this task to professionals. The very highest care should be taken to ensure the legal conformance of the prospectus in order to protect investors.

Furthermore, besides the prospectus which may be required, appropriate documentation and information must be available at each stage of the issue process. The success of a private placement depends considerably on its sales and marketing policies.

The issue process

In contrast to the stock exchange process, no specific time or date is set for a private placement (as is the case for an IPO); instead, the placement process is spread out depending on the range and distribution of the issue volume over a number of months, or in extreme cases, over years. This might initially appear to be a disadvantage, but it has the advantage of offering a higher degree of flexibility and independence from temporary market fluctuations.

The degree to which the private placement is limited to a small group of e.g. 5 - 10 private investors (such as in a Friends and Family issue) or distributed as widely as possible to > 1000 small investors must be determined during the planning process. The more the process leans toward the latter, the more the cost and complexity of the placement converge with those of a stock exchange IPO. This is often called a “Small Going Public” or “Pre-IPO”.

Investor Relations

As already mentioned, a private placement must include professional marketing measures. It would however be wrong to assume that these activities end with the completion of a successful placement.

For the company’s management, a private placement often marks the start of regular events as part of so-called “Investor Relations”. Here too, their type and range are determined by the planning of the private placement. When issuing participation certificates, for example, a regular letter to the investors is sufficient, while shareholders will expect more than a simple AGM.

Conclusion

Private placement is a timely instrument for corporate financing for high quality SMEs against a background of the increased importance of corporate paid in capital ratios. A private placement must definitely be extensively and competently planned as well as implemented. For many companies, a successful private placement has the additional advantage of moving them to a higher league. This theory is supported by a number of studies which indicate that companies non-stock exchange paid in capital grow almost twice as fast as their competitors, thus providing yet another advantage of corporate finance.

Contrary to the classical methods of company valuation, the purchase price is made ​​on the market. It is subject to strong psychological influences. Therefore, professional counselors always try to create an auction situation. Several bidders outbid themselves leading to a high purchase price.

A price-reducing effect, however, is the risk that a potential buyer subjectively perceives. An important objective in the preparation and execution of the transaction is to prepare a "good feeling" within the investor.

During the sale of small businesses the following critical points should be considered at all times:

  1. Owner independence

  2. Transparent business relations

  3. Properly kept books and a functioning controlling

  4. No dependence on major customers, employees or individual products

  5. Good process documentation.

If some of these points seem critical, you'll have to expect at least a price reduction, or, more often, the end of the sales process. From our experience we know that especially with owner-managed companies, a considerable preparation is needed. We need to "make the bride beautiful" and the before mentioned points need to be well structured for the sales process in advance.

If it is possible to create optimal conditions, this is significantly increasing the price. Appropriate arrangements are well spent in the interests of selling at a high selling price.

It goes without saying, that large companies hire an M & A advisor to manage their buying and selling activities. However in the SME sector, only about every fifth transaction is guided by an M & A Advisor. And yet, with the commissioning of an M & A advisory arise significant benefits:

  • Transfer of knowledge based on years of experience as an M ​​& A advisor
    J
    P Jäger & Partner is successfully active in the M & A business since 1978. 35 years of experience equals a high degree of expertise from a variety of projects.
  • Professional management of the M & A process
    Only the professional realization of the project leads to a good solution at an optimal price.
  • Visibility
    The commissioning of an M & A advisory shows the other side, that you're acting professional and are serious. In some cases it shows you are equally prepared, that's the case if the other party has also hired an M & A advisor.
  • Lower error rate
    Based on many years of experience in M ​​& A advisory, with the employment of an M & A Consultant, you spare yourself a lot of common problems. We often saw the other party giving away several million euros purely by ignorance and within minutes during discussions and negotiations - most don't even realize it!
  • Neutral and better business valuation
    Due to market knowledge in the sector of the transaction, an M & A advisor is in the position to argue an optimum business valuation to the other party in the situation. In combination with the optimal transaction structure, M & A advisors often achieve a significantly better rating for their clients.
  • Optimal transaction structure
    An M & A advisor has various options for structuring a transaction and draws on his many years of experience. We see it often, that the other party gets a transaction structure unfavorable for them, even though a better solution would have been possible and negotiable, just because of a lack of experience.
  • Moderation
    The authorized M & A advisor exclusively represents the interests of his client (the buyer or the seller) as opposed to a corporate broker. He will be conceived as a contact person in personal interviews and negotiations. The M & A advisor thus represents a second communication channel and is therefore able to clarify misunderstandings and dissolve hardened negotiating positions. He'll take emotions out of the M & A process, speed up the M & A process and explore negotiating positions in advance. A significant part of M ​​& A advice is to function as the "Bad Guy" in negotiations. Our many years of experience in M ​​& A advisory services, with buyers as well as sellers has shown that this moderating function contributes significantly to the success of an M & A transaction.
  • Significant workload reduction
    Corporate buyers and corporate sellers often underestimate the amount of work in the M & A process. We estimate the average amount of work for an M & A project on 50 - 80 man days. Even as corporate seller, it is fatal if the operating business is suffering due to the ongoing M & A process, which can be as long as 6 months or more. It is not uncommon due to the intense workload of the seller in the M & A process to fail at meeting the plan numbers communicated to the buyer and thus a significant reduction of the purchase price is a possibility.
  • Better coordination of the involved service providers
    In the context of an M & A transaction it is crucial to coordinate the various involved parties (lawyers, accountants, consultants). This coordination effort is usually considerably underestimated. If the service providers aren't properly coordinated and monitored, they often turn out to be a deal breaker.

As you can see the appointment of an M & A consultant makes perfect sense. As a rule of thumb, the benefits of the services an M & A Advisor provides, exceeds, by far, the cost.

Despite the current economic growth of around 6 percent [in 2013 International Monetary Fund] India is an attractive location. In particular, the demographic development with many young, ambitious people is offering a long-term perspective both in terms of the rapidly rising consume of a growing middle class, and the available production capacity.

This high long-term growth potential also plays a large role in the valuation of corporate transactions, so that the purchase prices, measured by the creation of value of the target company, are significantly higher than those in Europe, Brazil and even China. Especially compared to China, investors see clear benefits through the openness and (long-term) adaptability of Indian democracy, a competitive private sector, an administrative law system building on the former British system and the business language English. The disadvantage is that companies are often relatively small and only about 10% of M & A deals between Europe and India, have a transaction volume of over 100 million €.

Together with our partners in India, we can identify suitable acquisition objects, analyze them and support the transaction process.

Buying a company usually starts off in an informal manner. The board of a potential buyer gains knowledge of possible acquisition opportunities, for example during a personal conversation or over the phone.

Besides this effortless, yet more or less random, search many interested buyers are employing an unstructured search principle. But without well-defined and consistent search criterias, this principle can only lead to long and expensive processes. Needless to say, the results of this search are hardly helpful.

The acquisition of a company should be carefully planned and structured. In the real world, you would mostly use 4 steps to achieve these goals:

  • Step 1: Definition of the case-related „target properties“
    Just like the police, the potential buyers need to define themselves some search criteria for an attractive investment. As the search criteria are becoming more detailed, the results the search yields are getting better and better. The “target properties” should include structural, financial, market and product specialties.
  • Step 2: Compiling a comprehensive list of target companies (Long List)
    During this step, potential targets will be identified. This process is using the help of industry branch specialists, databases or the archives of associations and journals. During the, several weeks long, research process, the experienced M&A advisor uses his skills to filter the potential targets against the “target properties” and compiles the so called “Long List”.
  • Step 3: Determine the Short List
    The acquisition candidates on the “Long List” are now assessed by the buyer and the M&A advisor. Result is a so called „Short List“. This list sorts the targets by attractiveness.
  • Step 4: Screening of the acquisition candidates
    Possible targets are now screened during a specialized process. During this process the advisor writes a short profile for the first contact with the target.

This structured search process helps with the definition of given buying opportunities. The chances of a successful transaction are raised considerably. With more than 35 years of experience in the M&A business we’ve seen, that this type of a structured approach raises the probability of success by factor 10 or even more.

A cross-border transaction is an international company transaction in the form of a take-over or a fusion, from both the buyer’s or seller’s point of view.

As a rule, cross-border transactions involve parties from at least two countries. Compared to “simple” domestic business, cross-border transactions require a greater degree of experience and expertise. Thus, many medium-sized companies turn to experienced and competent consultants for assistance with the preparations, negotiations and execution of international M&A transactions to aid the realisation of the respective growth strategies.

In a corporate transaction, a preliminary purchase price is often agreed upon front, as liabilities and cash reserves can change between the date of the sales contract and the date of the transfer. It's even possible, that they were specifically "optimized" by the seller, e.g. with a short–term withdrawal of cash.

Therefore, the purchase price offer is drawn up, assuming that the company is cash and debt free: On the keydate, a correction of the agreed base purchase price, taking into account the difference of cash and debt and possibly the exception of a previously fixed net working capital, is calculated. The funding with wich the company should be handed over is fixed beforehand and adjusted to surrender to the changes at the keydate.

With a cash and debt free arrangement the purchase price is thus defined precisely. This includes a precise definition which balance sheet items are to be understood by cash and debt, in order to prevent any future disputes.

A successful outcome of a company sale depends significantly on a professional pre-selection of potential buyers. From our years of experience as M&A consultants we known that there are basically three groups of buyers to be approached with different intentions.

The most obvious group interested in corporate sales or succession planning are strategic investors. In their perspective on the acquisition is focused on customers, market share, geographic expansion (eg in an emerging market), portfolio diversification or due to the gain of valuable trademarks. The "strategists" is looking for a stable and well-functioning company that does not need huge action for improvement.

A different perspective is the one of financial investors, such as private equity firms (PEGs). Their expectation of an acquisition depends on their strategic orientation of high growth and profits in the following 2 - 5 years, like through the purchase of a non-profitable company. After this period a so-called. "Exit" is executed – the sale of the now restructured and value-added company. Thus an important role from the viewpoint of a financial investor is an intact and engaged management, which ensures the realization of the objectives set. Additional acquisitions, known as add-on investments are frequently one measure of PEGs, as the total value of a group is evaluated significantly higher than that of individual market players on time of exit. From our experience, financial investors are a very transparent, focused and highly responsive group that is often willing to pay higher prices than the strategic investors.

The third group to be considered are financial investors interested in a long term engagement like industrial holdings. Their targets mainly feature a large market share, good brand and a good reputation within a mature market. Thus they are gaining an increase in value of the company by additional acquisitions or geographic expansion within 5 - 10 years.

Our experience shows that the pre-selection of relevant interest groups is a key factor for a company’s sale process. In addition, you should be aware that each of the three potential buyers must be targeted and approached in their own suitable manner. Thanks to a well-developed strategy an optimized sale price by a most suitable buyer can be achieved. The foundation is an experienced consulting company that is able to offer such customized solutions to their clients.

The chance of success during an M&A Transaction, as in the whole market economy, depends on the balance between supply and demand, nevertheless, it is of the most importance to use a structured and systematic approach. This approach is composed of an in-depth analysis, a thorough research and an attractive information memorandum. During the discrete contacting of potential investors, the sales conversations, the due diligence and the final negotiations the process mainly relies on factual, emotional and tactical elements. Mainly objective and social authority as well as negotiation skills. The experience of the advisor is vital, too. We have over 30 Years of experience successfully realising M&A transactions prior in the sector of mid-sized companies.

During non-crisis times and with a careful selection of candidates for negotiation, we met first interest in about 10 - 20 % of the potential buyers contacted. About half of them is starting with the negotiation. From our experience, the chances of success during a structured M&A process are over 80 % with the assistance of a professional advisor.