Mergers & Acquisitions E-Book

Dennis J. Roberts

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 744

Veröffentlichungsjahr: 2009

Beschreibung

This book was designed not only for owners and managers of middle market businesses but as a training text for middle market M&A investment bankers and consultants. It discusses the art and science of middle market M&A as well the all-important psychology and behind-the-scenes negotiations pursued with a particular emphasis on obtaining the absolute highest value when selling a business. Subjects addressed include valuation, taxation, negotiations, M&A conventions, among many others from the buy-side and sell-side perspectives. Subtitled "Tales of A Deal Junkie," this serious but occasionally irreverent book tells it like it is, including anecdotes to provide a "feel" for what really goes on in middle market transactions. The author, a former practicing CPA and a business valuation expert, is a veteran M&A investment banker with years of real life experience. He also is a widely-acclaimed instructor in the M&A field and a nationally-respected practitioner who has trained thousands of investment bankers. No comparable book on the market today provides this degree of comprehensive and invaluable insight.

Leseprobe

Table of Contents

Praise

Title Page

Copyright Page

Epigraph

About the Author

Acknowledgements

Foreword

Preface: A Profession

A Career in Middle Market Investment Banking

The Origins of a Deal Junkie

The Deal Junkie Arrives (Almost)

Why Another M&A Book?

My Intended Audience

Happy Families

Disclaimers, Apologies, and Modest Lies

CHAPTER 1 - The Middle Market Is Different!

Business Process Innovation, Growth Spurts, Regulatory Imperatives, and Capital

Not “Mom-and-Pop” Businesses

The Upper Market

What Exactly Is the Middle Market?

Does Size (Alone) Matter?

Brokers and Investment Bankers Servicing the Three Markets

Chapter Highlights

Notes

CHAPTER 2 - Drivers of Middle Market Activity and the Sellers

Liquidity and Umbrella Drinks

Baby Boomers

Technology and the Information Age

It’s Not Your Father’s M&A World, Either

The Glass Ceiling that Sometimes Drives Transactions

Big Fish and Little Fish

Chapter Highlights

Note

CHAPTER 3 - Finding—and Understanding—Buyers in the Middle Market

Scared Money

Understanding Buyer and Investor Types

Identifying Potential Buyers

Which Door to Open to the Buyers?

Chapter Highlights

Note

CHAPTER 4 - Preparing a Middle Market Business for Sale and Running the ...

Three Periods to Prepare to Sell a Middle Market Business

Litigation

Summing Up

Chapter Highlights

Note

CHAPTER 5 - Rewarding and Retaining Key Staff in Connection with a Business ...

Overview

Key Employee Rewards in General

Timing Reward Payments

Timing Tax Issues in Rewarding Key Employees

The Importance of Clarity and Documentation—Avoiding Vague Promises

When to Negotiate Noncompete and Nonintervention Agreements with Key Employees

Being Alert to Potential Problems When Promises Made Are Not Consistent with ...

A Way to Avoid Key Employee Problems in the First Place

The Special Problems of Absentee Owners

Wrap-Up

Chapter Highlights

CHAPTER 6 - Crystal Balls and Timing the Sale of a Middle Market Business

Bubbles, Cycles, and Business Values

Other Timing Opportunities—Roll-Ups

Chapter Highlights

Notes

CHAPTER 7 - The Confidential Information Memorandum

The Acquisition Profile

Confidential Information Memoranda—Overview

Clients and Confidential Information Memoranda: An Intense Collaboration

Financial Statements in the Confidential Information Memorandum

Chapter Highlights

Notes

CHAPTER 8 - Confidentiality While Doing the Deal

Confidentiality in General

Employees and Confidentiality: Two Approaches

The Investment Banker and Confidentiality: Communications between Banker and ...

The Executive Summary and Confidentiality

Web Site Business-for-Sale Listings

Nondisclosure Agreements

Securities Laws and Confidentiality

Chapter Highlights

CHAPTER 9 - Middle Market Investment Bankers and Intermediaries

The Telecom Deal

Using Professional Investment Banking Assistance and In-House Teams

Choosing the Right Investment Bank

Chapter Highlights

Note

CHAPTER 10 - The External M&A Team, and Using the Team Correctly

The External M&A Team

Using the Team Properly and Sequencing the Professionals; Separating the Tasks ...

Chapter Highlights

Note

CHAPTER 11 - Anyone Can Do M&A—Right?

Anybody Can Do This?

The Deal the Client Never Got

Experience and M&A

Chapter Highlights

CHAPTER 12 - Two Types of Auctions: The Informal Auction and the Controlled Auction

Auctions in General

Document Rooms and Sequencing in the Controlled and Effective Auctions

Effective Auctions: A Summary

The Need for Auctions: What a Buyer Will Not Tell a Seller; How the Seller ...

Chapter Highlights

CHAPTER 13 - Financial Services Agreements, Estimating Professional Fees, and ...

Financial Services Agreements, Broadly Considered

Lawyers and Investment Banking Financial Services Agreement Reviews

Large Sums of Money and Odd Behaviors

Success or Contingent Fees Formulas (The Lehman Variations)

How Transaction Value Is Measured

Contingent versus Noncontingent Transaction Value

Escrow Set-Asides

Retainers (Commitment Fees)

Basic Contract Period

Trailer Periods

Breakup Fees

Carve-Outs and Approaches to Carve-Outs

Compensation to the Investment Banker in Warrants, Options, or Other Equity

Integrity and Investment Banking and Large Sums of Money

Bankers Fees Paid at Settlement—More about Large Sums of Money

M&A Lawyers and Fees

Clients’ Overall Estimate of Professional Fees for a Typical Engagement

Chapter Highlights

Notes

CHAPTER 14 - Investment Banking Representation on the Buy Side

The Buy Side

Buy- versus Sales-Side Representation

Buy-Side Fees

It’s All in the Planning

How Many Targets at One Time?

The Platform Philosophy versus the Financial Approach to Acquisitions

Who on the Buy Side Should Negotiate?

Orchestration (or Art) versus Science

Who Does the Investment Banker Represent? Possible Conflicts of Interest in ...

Chapter Highlights

CHAPTER 15 - The Letter of Intent: The Most Critical Document?

Content and Precedents of a Good Letter of Intent

The Buyer/Seller Advantage Curve

Preliminary versus Confirmatory Due Diligence

Exclusivity, Confidentiality, and the Letter of Intent

Affirmative Response Clauses

Weaknesses and Opportunities—Disclosure and Accuracy of Preliminary ...

The “Honey, I Did the Deal” Rule . . . Thoroughness of Business Terms

Use of Subtlety and the Effect of Precise Words in Letters of Intent: What the ...

Negotiating Protocol and the Letter of Intent

The Reverse Letter of Intent

LOIs from the Buy Side Point of View

Chapter Highlights

CHAPTER 16 - Some Thoughts on the Psychology of M&A Negotiations

A Few Preliminary Thoughts on Negotiation

Preparation

Clients and Negotiation

Politicians and Honesty

Honesty and Integrity Are Still the Best Policies . . .Making a Friend

Dangers of Written Argument

Every Deal Dies a Thousand Deaths

The End of the Middle Part of an M&A Negotiation . . .Just Before the Letter of Intent

The Difficult or Unreasonable Negotiator

One Last Thought on Negotiations: A Confession

Chapter Highlights

Notes

CHAPTER 17 - Initial Meetings with Buyers, Pricing the Company, and Pacing the Negotiations

Strange Role Reversals and First Meetings

Encourage All Offers, No Matter How Low . . .Getting Them into the Tent

The Truth, the Whole (?) Truth, and Nothing but the Truth

Timing, Sequencing, and Pacing the Deal while Pricing the Company

Chapter Highlights

Note

CHAPTER 18 - Consideration and Deal Structure

It’s the Terms, Not the Price, Stupid!

Consideration and Consideration Types

Deal Structure

Frequently Offered Consideration Types—Overall

In Summary: Weighing and Comparing Offers

Recommending Against Deal Consideration

For Buyers: Creative Uses of Consideration as a Deal Making Device

Stock and When It Is Priced

A Final Thought on Consideration Mixes

Chapter Highlights

Notes

CHAPTER 19 - Earnouts

Why Earnouts Are Dreaded but Very Frequently a Deal Component

Whose Earnings Are These Anyway?

Avoid Confusion: Understand the Differences between Two Types of Earnouts

Elements of Negotiation in a Comfort (True) Earnout

Bottom Line Earnout Metric (EBITDA, etc.)

When an Earnout Is Simply Frosting on the Cake

Earnouts and Taxes

Chapter Highlights

CHAPTER 20 - The Proof Phase, or the Final Days

Confirmatory Due Diligence

The Definitive Agreement

The Final Days: Investment Bankers and Attorneys

The Critical Importance of Speed in the Final Days

The Closing and the Surprise at Closing

Chapter Highlights

Notes

CHAPTER 21 - After the Nuptials: Postmerger and Acquisition Failures

A Brief Honeymoon, Perhaps; A Successful Marriage, Less Frequently

Chapter Highlights

Note

CHAPTER 22 - Does a Sales-Side Client Need an Appraisal before Going to Market?

Four Basic M&A Marketplace Valuation Contexts

Formal versus Preliminary Valuation in the Marketplace

Investment and Dynamic Value

The Answer

Appraisal Costs

A Preliminary Valuation in the Marketplace

Chapter Highlights

Notes

CHAPTER 23 - The Rules of Five and Ten and the Super Rule of Five in M&A Valuation

A Foundation for the Valuation of Middle Market Businesses

The Rules of Five and Ten, Cocktail Party Conversation, and . . .Quick Calculations

Two Bell Curves

The Super Rule of Five

The Greater Fool Theory (Buyer Beware)

Chapter Highlights

Notes

CHAPTER 24 - An Introduction to the Basic Art and Science of Valuation ...

So How Much Is It Worth? Valuation 101

Valuing Economic Assets in General and Business in Particular

M&A and EBIT(DA)

Another Approach to Valuation: The Discounted Future Earnings (DFE) Method ...

Chapter Highlights

Notes

CHAPTER 25 - A Brief Discussion of Multiples and Multiple Realities

Multiples in General

Risk and Multiples

Derivative Multiples versus Actual Deal-Driving Multiples

Public Market versus Private Market Multiples

Arbitrage and Roll-Ups: A Practical Example of Public versus Private Company ...

Chapter Highlights

Notes

CHAPTER 26 - Qualitative Values Inherent in the Target Company

Quantitative and Qualitative Valuation

Two Law Firms

Value Drivers Go Well Beyond the Numbers

Obsolescence, or . . . Go into Plastics, Young Man

The Use of a Value Driver Analysis Contained in a Preliminary Valuation Report

Chapter Highlights

Note

CHAPTER 27 - M&A Conventions and Establishing Balance Sheet Targets

Conventions and Their Need and Basis

The Balance Sheet in General

M&A Conventions in General

Entities and Businesses—Redux

M&A Balance Sheet Conventions, or, Who Gets the Balance Sheet?

Other Nonoperational Assets beside Cash

Establishing Targets for Deliverables, Usually the Balance Sheet—A Moment in Time

The Balance Sheet: At the Time of Negotiation or at the Time of Settlement?

Working Capital Targets on the Balance Sheet

Net Worth Targets on the Balance Sheet

Double-Counting Target Purchase Price Adjustments

Settlement of Differences—Truing Up

Operating in the Normal Course of Business

The Balance Sheet and Normalization

Chapter Highlights

Notes

CHAPTER 28 - Special M&A and M&A Valuation Topics

Overview

Valuing Real Estate on the Balance Sheet

Technology Valuation: Is It a Business Yet?

Valuing the Nonprofitable Business

Valuing Rapidly Growing Businesses for Venture Capital and Similar ...

Chapter Highlights

Notes

CHAPTER 29 - Common M&A Taxation Issues

A Brief Tax Overview

Entity Selection: S Corporations versus C Corporations and Asset versus Stock Deals

The Effect of Timing of S Corporation Elections and the Built-In Gains Tax

Other Transaction Structural Issues

Earnouts

The Effect of Tax Accounting Methods

Reorganization Deal Structures (Taking Stock)

Disposing of Business Interests by Gifting Prior to a Sale and Charitable ...

Divisive Reorganizations

Small Business Corporations

How Much Do Taxes Matter During the Negotiation?

Chapter Highlights

Notes

CHAPTER 30 - The Business of Middle Market Investment Banking

What Is Investment Banking?

Some Ironies of the M&A Profession

Attention Deficit Disorder and the M&A Banker

People Skills

Entry Points to Investment Banking in General

Cultural Issues in Investment Banking Practices—Some Further Thoughts

Marketing: Half of Investment Banking Is Business Development

Multiple Marketing Approaches

Networking in General

Serving Clients and Executing Engagements Well

Securities Law Issues

Engagement Intake Management

Success in Life and M&A

The $10 Trillion Opportunity

Chapter Highlights

Notes

CHAPTER 31 - A Postscript: The Capital Markets

Notes

CHAPTER 32 - Another Postscript: The Unbundled Approach to Formal Valuation

A Bird, a Plane?

Notes

Index

More Praise for

Mergers & Acquisitions: An Insider’s Guide to the Purchase and Sale of Middle Market Business Interests

“Mr. Roberts has written a timeless contribution to the art of getting business transactions completed. His years of experience allow him to provide invaluable insights into the nuances of successful deal completion. It gets better: The wisdom is communicated in a highly readable format spiced with on-point illustrations, examples, stories and informed opinions. This book must be on the short list of every investment banker and business owner seeking to gain that all important advantage in today’s competitive markets.”

—Scott D. Miller, CPA/ABV, CVA, author of The Adviser’s Guide to Mergers, Acquisitions, and Sales of Closely Held Businesses: Advanced Case Analysis and Buying and Selling Businesses: The CPA’s role.

“Dennis does a tremendous job of looking beyond all of the technical jargon that clutters the world of investment banking, and focusing on the key elements of how deals actually get done. This is a refreshing book, with engaging real-world teachings and clever insights from one of the masters of mid-market M&A.”

—Howard Johnson, President, Veracap Corporate Finance Limited, Toronto, Canada

“Dennis understands the psyche of the middle market and translates his years of experience into a practical, entertaining yet technical text. Bankers and business operators, on either side of a transaction, will benefit from studying at the foot of the master.”

—Martin O’Neill, Author, Building Business Value and Coauthor, Act Like an Owner

This book is printed on acid-free paper.

Copyright © 2009 by John Wiley & Sons, Inc. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:Roberts, Dennis J. Mergers & acquisitions: an insider’s guide to the purchase and sale of middle market business interests / Dennis J. Roberts. p. cm. Includes index.

eISBN : 978-0-470-44275-3

1. Consolidation and merger of corporations—United States. I. Title. HG4028.M4R626 2009 658.1’62—dc22 2008035469

“Some men know the price of everything and the value of nothing.”

Oscar Wilde

About the Author

Dennis J. Roberts, CVA,CPA*/ABV (*no longer practicing), is the chairman of a very active M&A investment bank (The McLean Group) with offices in approximately 30 cities in the United States and Canada. Having acted as the investment banker advisor on numerous transactions over many years, he is also a formal business valuator, having done such prominent business valuations as the Nixon Watergate tapes. He was also the founder and chairman of a multistate regional commercial national banking company. He was a member of the initial committee that established the first eight part AICPA training modules on business valuation for CPAs. He has lectured, taught, and authored courses on M&A subjects for numerous audiences and professional groups, such as the National Association of Certified Valuation Analysts, The Alliance of Merger and Acquisition Advisors, university graduate programs, and many others, including having been engaged as a lecturer by other privately owned M&A investment banks. He lives in Fairfax, Virginia, with his wife Robin Quattlebaum.

Acknowledgments

Acknowledgments seem almost routine, a mere formality . . . but they are not to authors. This is a very small and totally inadequate way of saying “Thank God you were there, or my screw-ups would have been even greater than they are.” Not that any of the following contributed in any way to those screw-ups that still remain.

Thanks to Steve Meltzer and Enrique Brito for very detailed word-by-word reviews; Joe Loughran for very helpful edits of my early drafts; Andrew Smith, Andrew Sherman, Chuck Andrews, and Scott Miller for useful insights and comments that I incorporated in one way or the other; Howard Johnson, my co-teacher, who helped me develop many of the thoughts and the overall body of knowledge here years ago (albeit with a Canadian accent); William Offutt, who reviewed and made excellent suggestions on the tax chapter of the book; and all of them for their intelligent comments, observations, and “in the nick of time” course corrections.

Parnell Black, the founder and CEO of The National Association of Certified Valuations Analysts (NACVA), and Mike Nall, the founder and CEO of the Alliance of M&A Advisors (AMAA) deserve special mention, as they were both instrumental in my own learning by allowing me to teach and create courses for them over many years.

Again, as in most books, I would like to make a dedication—but in no way as a mere matter of routine, for without the love and patience of family, I would not be able to do what I do. So;

To my childrenDebbie, Cathy, and David And my wifeRobin Quattlebaum

Dennis J. Roberts, 2008

Foreword

A difference of opinion is what makes horse races and missionaries.

Will Rogers

Blessed are they who can laugh at themselves, for they shall never cease to be amused.

Anonymous

This book is intended as a textbook and perhaps a reference book for training those who seek a Middle Market investment banking career. It is intentionally not meant to be a “technical” book. Enough of those have been written, and I do not believe we need yet another. Enough of my students over the years have either had technical training (accountants, valuation experts, MBAs, finance majors, and so forth), or maybe do not really care to go into those subjects too deeply (business owners, managers, and entrepreneurs).

In fact, the problem in my view with most Middle Market M&A texts is that they are too technical at the expense of “feel,” and feel is what my students tell me they want. Were I to organize a course from scratch (and I have), I would first teach the elusive feel and only later add the technical subjects that flesh out feel and are frankly secondary to it.

In the 1930s, Percy Boomer wrote one of the best books on golf ever written, On Learning Golf. Percy rightly believed golf was mainly about feel. In this regard, Middle Market M&A quite arguably is a lot like golf. A thorough knowledge of technique alone always proves a poor substitute for a honed feel of the swing in each transaction. Even though I took it up rather late in life, I love golf. Initially I read everything I could put my hands on in terms of the golf swing but it was often (in fact usually) years later only when I successfully actually did something that I had read about that the light came on: “Oh. That is what they meant. I can actually feel it.” While there is a limit to what a book can do, what I have attempted here is to short cut some of that time between acquiring technique and experiencing “feel.”

Another virtue of this book is that it uniquely addresses not only the art and science of Middle Market M&A but, at the same time, the buy and sell sides, while admittedly placing more emphasis on the latter.

Finally, other M&A professionals and investment bankers might glean something from peeking into the tent of a fellow M&A professional’s experiences, if for no reason other than to satisfy their curiosity. And if this book should happen occasionally to fall into the hands of a Middle Market business seller, or buyer, or capital seeker, then so be it. That would not displease me at all, as there is information here that will be of much assistance to them, too, in conducting their own transactions. It might also prove of use to them in the choice of the best banker available for the task at hand.

I want to warn my readers up front that they are likely to encounter a lot of apparent redundancy in this book. This is for two very conscious reasons: First I have always taught that way, starting with the general and then restating it but in increasingly granular levels. The second is that by its very nature, M&A and this book as result cannot be either proceed nor be taught in an entirely linear fashion. For example, the concepts of preliminary valuations, Letters of Intent (LOI’s) and balance sheet conventions among others by necessity need to appear in various chapters but in slightly different contexts. Also because this book was written to be a reference book as opposed to a “read straight thru” book for those who preferred it that way, I will occasionally repeat some earlier material for the convenience of my readers.

Preface: A Profession

A Career in Middle Market Investment Banking

Since my early days, I have never looked back. Never made so much money either (or gone for such long stretches wondering where the next payday was coming from), but after a while money doesn’t mean that much. I think the excitement of dealmaking is a sufficient reward in itself for those of us attracted to this kind of work.

And you meet some pretty cool people too, even in the Middle Market. Heads of state of very large nations, admirals, generals, senior White House officials, senators, congressman, cabinet officers, CEOs of many large companies and many more smaller ones, private equity group and angel investors, all equally interesting people. Not everybody may want to be a dealmaker (actually, in my heart, I think they do), but everyone seems at least intrigued by what we do.

And it leads to the damnedest places. One of my jobs as an investment banker and valuation analyst was to value the Nixon Watergate tapes—who would have thought? I wouldn’t trade this career for anything, with the possible exception of time with my family and my periodic sojourns to my home in Mexico for tequila and sun breaks.

The Origins of a Deal Junkie

Washington, DC—March 1967andManhattan, New York City—June 1970

As a newly minted—and very wet behind the ears—CPA, I sat at my desk in a client’s office in suburban Washington, DC, ticking off audit steps and found myself quite frankly bored to death. I could not imagine doing anything remotely similar to this kind of work for the rest of my life. The notion of how stultifying this work was became even clearer to me as I overheard apparently intense negotiations transpiring in the office next door. Just a few feet away from me, on the other side of a very thin wall, the owners of our client firm, a decent-sized construction company, their investment banker, and a team representing the prospective buyers were hammering out a proposed merger agreement. I couldn’t tell exactly what was going on, but I had enough of a clue to know that I was interested.

Three years later, having made some progress up through the accounting ranks, I found myself in the richly furnished and very large board room of a Wall Street investment bank, listening attentively to a similar and no less heated discussion regarding the merger of a large Middle Market company, to be followed by an initial public offering (IPO). I was there as an audit support staff member for a CPA firm (and pretty much tolerated as a trained fly on the wall) as some of the critical issues that bore on whether this multistage deal was to get done were of an accounting nature. The alternate pounding on the table going on between the chairman of the major investment bank and his associates on one hand and the senior audit partner of a “big eight” accounting firm and his fellow auditors on the other was exciting and intimidating to me at the same time. Frankly, it was like watching tag-team wrestling in suits.

Those two particular experiences, in Washington, DC, and New York City, had given me a peek inside the tents where, in my opinion, the real gods of business, at least the ones that grabbed my attention (dealmakers), held court, consummated mergers, and did acquisition transactions. They most definitely were not dazzling, white-bearded men in white robes inaccessible to mere mortals like me. But in the moment they might as well have been, because even though I knew I wanted to walk among them, I didn’t know how to get there. And I had to get there, because simply hearing and seeing them do their deals got my juices flowing. Let others start and run businesses, account for them, keep them out of legal trouble, and/or market their goods and services. Those jobs were not for me. I wanted “to do deals,” even if I wasn’t yet clear as to what all that entailed.

The Deal Junkie Arrives (Almost)

Savannah, GA—May 1989

My brand new partners and I were ensconced in offices located in a pleasant and recently revitalized part of town, close to the river. There was an attractiveness there that derived from a particularly successful blending of the qualities of Old and New South. I was really happy to be there. Looking around the boardroom table at my new colleagues, I thought, I have found it. After 20 years of enjoying the wheeling and dealing of financial services transactions close to but not really directly in the M&A arena, I believe I have finally found a place where I can capitalize on everything I have learned along the way by just, well . . . doing deals. In the industrial south, this relatively small boutique firm had a great reputation for executing the kinds of transaction in industries that were traditional for the south at that time: textiles, furniture, food manufacturing and services, and so on. The information technology boom was still a few years away. On that May 1989 afternoon in Savannah, I wanted to believe the sunlight streaming into our boardroom was a harbinger of good things to come. But even then, I had much more work and much more learning to do.

By 1984, my experiences as a senior partner in public accounting, focusing a good deal of my career on transaction advisory services, had led to my becoming founder, chairman, and CEO of a publicly owned, multistate banking company. A few other entrepreneurial undertakings, launched in my spare time, also had proved instructive, as I developed at least a few (fewer than I realized) of the necessary skills for successful M&A investment banking. But I was totally prepared to live by my wits and experience, and I was sure that with just a little additional refinement of my skills, I would be ready to go. Or, at least, so I thought. Certainly, the complementary skills of my new partners gathered around our boardroom table were all I needed now. But this was not quite true . . . as I was to find out.

Why Another M&A Book?

What I would come to understand soon enough was that there was no better place to learn what I needed to learn than on the job, dealing with real-world M&A deals mainly. My partners would prove helpful, of course, but only intermittently so. In part, this reflected a simple fact of life: Middle Market M&A investment banking was a notoriously unstable business and, as a result, its practitioners faced very high career “mortality” rates. Relatively few Middle Market M&A intermediaries weathered the financial valleys (deep and sometimes protracted) in this very lumpy and cyclical business long enough to enjoy the rewards of teaching the next generation. Furthermore, a lot of the professionals in this business, being retired industry executives, were doing M&A consulting as a sort of retirement avocation and were somewhat lone wolves, only in it for few years.

A recent Internet Amazon search for M&A-related books identified over 26,000 references in seconds. Doubtless, there are more out there. So why write another? In point of fact, very few books separately address the unique issues and circumstances of Middle Market M&A. Colleagues, students, clients, and other Middle Market M&A practitioners tell me the same thing. The books that do address the Middle Market often fail to acknowledge the very different circumstances, perspectives, and practices of the sales-side on the one hand and the buy-side on the other, addressing the two as if they were all but interchangeable. They are not. As a result, inexperienced practitioners, prospective clients, and readers may well walk away with serious misconceptions of the differences in practice between the two sides. I frequently have seen novice sales-siders, overconfident due to having read one text or another on Middle Market M&A, rushing into meetings to support their clients’ positions with all manner of financial models and calculations that would be more appropriate on the buy side.

Middle Market M&A literature today also tends to address the art of the deal or the science of it, but seldom both. The art and the science are equally important and ever-present in the real world. Developing a facility for one at the expense of the other routinely proves less than ideal.

And then there are those who do and those who teach. Much of our Middle Market literature appears to me to have been written by authors who do not really do deals (business valuators, accountants, etc.), and while these books can make a valuable contribution, they do not give a sense of the feel of M&A, as it is practiced outside of a textbook or a classroom.

In quarterly board meetings with my partners in Savannah over the next few years, I came to realize that most of them were “winging it” to some degree as they did their M&A deals. I learned that many M&A transactions are facilitated successfully almost in spite of the alleged professional firepower hired by clients. But deals got done. It was as though the “Will to Transact” itself was sufficiently powerful to overcome many obstacles, including the more-than-occasional lack of experience or necessary capabilities on the part of some of the Middle Market investment bankers ostensibly managing the transaction process.

My Intended Audience

Over the course of the past 15 years, I have traveled extensively to teach Middle Market M&A fundamentals to business owners and executives, attorneys, accountants, and business valuation experts serving a Middle Market clientele, as well as some seasoned and some newly minted investment bankers. Some of the bankers are at the beginning of their careers, and some of whom enjoy swapping war stories and experiences with another veteran of the M&A wars. What I gained over time by teaching innumerable seminars and workshops to these three groups was a growing insight into those different perspectives.

I admit to having slanted this book more to the sales-side perspective—consciously and for several reasons without having ignored the buy side altogether however. First, most buyers are larger companies with professional, in-house M&A and corporate development staff. Many, if not most, sellers will complete only one or two M&A transactions in the course of a career. Yet that deal (or those deals) most likely will be the largest and most significant financial transactions of their lifetimes. By definition, the inexperience of these essentially novice sellers can prove financially catastrophic as they negotiate transactions with a buyers’ full-time, professional M&A staffs. This book is partly written to help them prepare for such transactions and to provide some suggestions as to what to look for in the sales-side M&A investment bankers and other professionals they will hire to protect their interests throughout the process.

But I also hope this book will prove of some value to in-house, professional buy-side M&A practitioners, as it addresses the techniques employed by professional, sell-side investment bankers in negotiating and transacting deals. Having trained buy-side in-house staff, I often have found them in want of an appreciation of the sales side and its techniques, which too often can put the buy side at a disadvantage it does not need to suffer.

Happy Families

As Tolstoy said, “Happy families are all alike; every unhappy family is unhappy in its own way.” The ways to ineptly sell, or buy for that matter, a Middle Market business in the six to twelve months typically required to close a transaction are legion. This book will address the many challenges, pitfalls and difficulties inherent in transactions involving Middle Market businesses. Admittedly, every M&A transaction is, by definition, unique but they also share many commonalities, even across industries.

After all the deals, all the clients, all the books, and all the colleagues met along the way (good and bad), I believe I’ve learned a great deal about the work I love. But I have never found all I’ve learned about the art and the science of the Middle Market M&A work I’ve pursued for half a lifetime brought together in one place. That is why I wrote this book, and I hope my fascination with and love of this profession comes through clearly and will be shared by my readers in a sufficient number of cases to have made this worth the writing.

Dennis J. Roberts McLean, Virginia (Washington, DC) November 2008

Disclaimers, Apologies, and Modest Lies

I have a higher and greater standard of principle. Washington could not lie. I can but I won’t.

Mark Twain

A little inaccuracy sometimes saves a ton of explanation.

Saki (H.H. Munro)

Every war story or anecdote recounted in this book to illustrate one principle or another is true. Even so, fictitious names, dates, locations, and transaction amounts are employed in the retelling to preserve the privacy of all parties to these transactions and events. My use of some obfuscation reflects a continuing commitment to preserve my clients’ confidentiality, even years later. Like most investment banks, my firm publishes “tombstones” reporting summary transaction information with the prior approval of our clients. As a result, if a sleuth in our Google world succeeded in matching an anecdote to a tombstone, I and my investment bank might well face an outraged former client whose trust we would have violated.

This book has been written over a number of years. Much in it has been inevitably addressed elsewhere in the huge plethora of M&A literature (maybe 75% of the material, with the balance being some notable exceptions, such as M&A conventions, the Rules of Five and Ten, pricing a company, etc.) but my point was to bring it all together in one place for the first time. If I have failed to appropriately credit any of my sources (crypto-amnesia), it is only because after 15 or more years of sporadic writing and teaching, it is impossible to remember where I learned all of this myself. I do know that some of it certainly came from my own reading but only if corroborated by subsequent experience, much more of it from original on the job experience, and a good deal of it from my colleagues.

Finally, I have written this book so that it can be read straight through or can be skipped around as one desires and finds useful.

CHAPTER 1

The Middle Market Is Different!

Business Process Innovation, Growth Spurts, Regulatory Imperatives, and Capital

Historically, at least for the last 120 years or so, the United States’ mergers and acquisitions (M&A) activity has paralleled business growth spurts, regulatory imperatives, or both. In turn, business growth spurts have been driven by business process innovation, particularly in transportation and communications infrastructures and most recently in technology. A third ingredient for this stew, along with businesses growth spurts and regulatory imperatives, is the need for ample excess capital to properly flavor the pot.

In the late 1800s and very early 1900s, the real and effective establishment of a national railroad system was a primary driver of a rapidly expanding U.S. economy, and of course high stock prices and new capital were an accompaniment. Typically, during periods of innovation, monopolies or seeming monopolies tend to develop (witness Microsoft in our own era), people complain, regulators react, and thus did this first wave finally slow down with a 1904 U.S. Supreme Court decision which frowned upon the monopoly situations and the ever-larger companies that were developing. In fact, the first regulation to emerge regarding M&A in the United States was the Sherman Act in 1890.

By the 1920s, the continued substantial improvement of transportation (automobiles and trucks) and communications systems (widespread use of radio and telephone) were driving a thriving U.S. economy. A booming stock market meant abundant capital, and mergers and acquisitions predictably resulted. Since horizontal merger activity had been discouraged by the Supreme Court earlier, the tendency during this period was to merge forward or backward through the supply chain. History has well memorialized that this wave in turn ended with (but that is not to suggest that it caused) the 1929 crash of the stock market; the impediment to the capital markets was to last at least 30 years.

Despite the World Wars, 30 fairly quiet business years followed, with steadily increasing improvements in infrastructure. These improvements occurred partly out of concern for national transportation policy prompted by the wartime activity of the Second World War, and of course communications took center stage again (television) as a marketing device. By the 1960s, 14 years after World War II, business seemed ready to truly grow again. Fourteen years of veterans’ housing programs and job and educational opportunities began to show real results in the economy. Another factor, the “military industrial complex,” accompanied growth in national government spending. By this time, though, regulators and politicians were opposed to either type of merger, sideways or up and down, that might impede free competition. The result was a tendency toward mergers and acquisitions to form conglomerates, driven by the desire to employ capital and grow large without running afoul of regulators, politicians, and courts. But conglomerates were not succeeding particularly well because focus and as a result, good operating practices were dampened. In addition, the passage of antitrust laws started to make even conglomerate mergers of disparate parts more difficult.

M&A resumed again in the 1980s, fueled by junk-bond financing, leveraged buyouts, and strong stock prices. It was also driven in part by financial engineering—mostly from arbitrage, in which the real money was made from the deal by the promoters themselves as opposed to improved operations. The 1980s’ financially engineered deals were somewhat different from the type we were to see in the 1990s (many now in the Middle Market) from roll-up groups.

By the 1990s, we were beginning to see a great influx of capital driven in one way or another by the productivity and consumerism of those ubiquitous baby boomers (the sons and daughters of World War II veterans), the youngest of whom were then entering their 50s, as well as from the abrupt turn toward deregulation of industries such as banks, utilities, communications, and airlines, among others. Consolidation was another factor and to some degree a result, especially when it was conducted by the financially engineered roll-up groups, which, just like their counterparts in the 1980s, made their money when the deal was done by rolling up and repackaging Middle Market businesses as public companies, not as a rule by conducting sound financial operations. Of course, the mid-1990s was also the dawn of the information age, and that too was accelerating the pace of business and the pace of change in business enormously. The end of this last wave paralleled the telecom and dot.com crash of 2000. Much of M&A was Wall Street activity, but a more than gradual and steady incursion was coming from the Middle Market and Main Street in the 90’s.

Since 2003, we have been observing another wave that by now heavily involves the Middle Market. The Middle Market, as of early 2008, accounts for approximately 300 to 350 deals per quarter in the United States and Europe respectively, when the deals are defined as those with transaction values in excess of $30 million. Larger business are seen as necessary to successfully compete in the competitive global economy as well as in cross-border transactions, which are of course a product of that global economy. Technology, often developed by Middle Market companies, is being acquired by larger companies through acquisitions. In addition, massive changes in the health care, communications, and financial services industries (usually associated with technology advances) are also drivers, especially Middle Market drivers. Increased government spending associated with war and terrorism, as well as huge influxes of capital from private equity groups and hedge funds, are also real factors.

Not “Mom-and-Pop” Businesses

I did not write this book to address the roughly 80% of U.S. businesses (Mom-and-Pop businesses) that typically are served by business brokers. But I do want to discuss them briefly.

Mom-and-Pop businesses typically are valued using rules of thumb that are not grounded in finance theory, particularly return on investment calculations. Furthermore, Mom-and-Pops typically generate very little interest among the predominant strategic and financial buyers of Middle Market businesses. If I define “Mom and Pop” as businesses with at least one employee and with less than one million dollars in annual sales there are some 4.5 million of them in the United States and these resoundingly affirm the genius of Adam Smith: capitalism really does work and flourish. Mom-and-Pop businesses are also frequently called “lifestyle businesses,” because quite often their proprietors launched them to suit lifestyle preferences: to escape the “rat race,” to control their own destinies, or just to get a foothold in American capitalism. Such lifestyle businesses often result in longer hours and far greater challenges for their founders/proprietors than the former nine-to-five jobs ever required. Still, the financial and psychological rewards can be significant.

Mom-and-Pop businesses provide an underpinning for our economy. They constitute the starting line in the entrepreneurial marathons for millions of citizens, who in turn employ millions more. While most Mom-and-Pop businesses will remain Mom-and-Pops throughout their business lifecycles, many thousands of them eventually will become Middle Market businesses. In addition, first- and second-generation entrepreneurial families running corner stores across America frequently produce third- and fourth-generation MBAs and CEOs in the Middle and Upper Markets.

For the most part, though, Mom-and-Pop businesses cannot be valued with the primary techniques used in the Middle Market, in which business valuation is based on return on investment (ROI). The impracticality of applying Middle Market valuation tools to Mom-and-Pop firms quickly becomes obvious. Why would someone pay, say, $300,000 (probably on terms) to buy a corner business that nets its owner $60,000 a year in return for the owner’s 80-hour work weeks? So Mom-and-Pop businesses tend to be valued according to rules of thumb that take into consideration their type and other factors, but typically do not give that much explicit weight to return on investment.

The Upper Market

Nor is this book intended to address the Upper Market, which usually is considered to comprise companies with $1 billion or more in annual sales.1 Such companies in turn command valuations of at least $500 million and up—often considerably more in the case of publicly held companies. Upper Market businesses account for less than 1% of U.S. firms and are mostly, but by no means always, public companies. Middle Market firms, unlike their Upper Market counterparts, typically are owned by ten or fewer individuals. Often, they boast only one owner. Upper Market firms generally are publicly owned by thousands of stockholders.

In the Middle Market, the term merger is for the most part a misnomer. A merger fundamentally implies that both companies will continue to exist with more or less the same original owners (stockholders), albeit in a combined sort of way in the form of a new and larger company. This scenario is much more a “Wall Street” or Upper Market phenomenon than it is a Middle Market concept. In the Middle Market, the vast majority of deals involve acquisitions, in which one company and its shareholders acquire another company, and the shareholder-owners of the acquired company are no longer involved in its ownership.

Furthermore, the idea of hostile takeovers is also pretty much a Wall Street or Upper Market phenomenon, as the majority of Middle Market companies are not publicly owned and thus not subject to hostile takeovers.

Additionally, whether the deal is accretive or dilutive is not usually a real issue (as it is in Upper Market deals) when it comes to the effect on earnings in Middle Market deals. There is usually no public stock market to judge, more or less immediately, the deal and the immediate increase or decrease in the blended trading prices of the two companies’ shares.

Finally, the time it takes to market and sell a Middle Market company is usually far longer (6 to 24 months) than the time it takes to do a deal in the Upper Markets, especially as Upper Market companies are more frequently one-on-one deals, whether hostile or friendly. The Middle Market is fundamentally inefficient when it comes to M&A transactions. As a result of Middle Market owners’ natural concerns with confidentiality, a central computer-based market (i.e., a stock market, where these businesses could be traded) is basically impossible and impractical. Difficulties in finding all possible capable buyers contribute to this inefficiency. For these and other reasons startup investment banks who deal in the middle market typically have very short life spans, estimated at 24 to 36 months, and usually employ only one or two people. While success payoffs can be large, this is not a field for the faint of heart or for those with a paucity of cash reserves. I intend to make the reasons for this apparent later in this book.

What Exactly Is the Middle Market?

The Middle Market is extraordinary for its diversity and breadth of opportunities. But what exactly is the Middle Market? A typical characterization among M&A professionals views the Middle Market as businesses with values of from $1.5 million to $250 million. Others suggest that Middle Market businesses range from $5 million to $500 million in value. The point is, there is no standard definition.

For example, Bank of America Business Capital defines Middle Market firms as those businesses generating revenues of between $25 million and $1 billion. (This would suggest that their sizes in terms of value are $12.5 million to $500 million). As defined by the Bank of America, some 50,000 Middle Market businesses account for approximately 25% of the U.S. gross national product (GNP). On the other hand, the U.S. Department of Commerce reports that there are approximately 300,000 Middle Market companies that, according to its own definition, generate $5 million to $250 million in annual revenues.

To put the M&A business opportunity for Middle Market investment bankers into perspective, consider this: The U.S. Census Bureau, in 2002, estimated there were a total of 5,697,759 businesses in the United States,2 with aggregate sales totaling in excess of $22 trillion. Assuming a very conservative two-to-one revenue to value ratio,3 that equates a market value of $11 trillion. While the census data indicates that many of the totals are small businesses (under $1 million in sales), just over 21%, or 1.2 million, are Middle Market firms with sales of $1 million to $1 billion annually. Collectively, these 1.2 million firms had sales totaling $9.8 trillion and carry a conservative market value of $4.9 trillion.

Middle Market business also constitute a driving force in the U.S. economy, accounting for fully 68% of our GNP, according to the Department of Commerce. Clearly, no matter how you slice it, the Middle Market is huge as an engine of the U.S. economy. It also presents incredible opportunities to investment banking specialists representing its business owners.

If we assume the widest range of revenues ($5 million to $1 billion), this translates into business with average values of about half that, or $2.5 million to $500 million. This definition is probably a pretty good one that most would accept. Furthermore, in practice, most M&A professionals agree that the lower Middle Market (which is the most robust segment of the Middle Market in terms of numbers of deals) is in the $2.5 million to perhaps $150 million value sector which could also be stated as $5 million to $300 million in sales.

Does Size (Alone) Matter?

Even size can be a gray area in defining the Middle Market, though. Many ostensibly Middle Market businesses generate sales of between $4 million and $8 million without ever being of any interest to strategic buyers. These are very difficult firms to find buyers for, as they are of no interest to strategic buyers and too large for individual buyers. Many of these firms will take two or more years to be sold or perhaps will never be sold, at least other than to management, which is something that should always be given serious consideration in these cases. If they are fortunate, they might be sold to another buyer in the same industry, but not one that has formally mounted a strategic acquisition program (thereby truly meeting the definition of a “strategic buyer”) in other words a passive buyer and therefore not willing to pay top dollar. These same-industry buyers are what I will call later opportunistic industry buyers. I would suggest that such ostensibly Middle Market firms as I describe here are in fact are really larger and more sophisticated Mom-and-Pop hybrids.

But just as there are firms that would qualify as Middle Market on the basis of revenues but for all intents and purposes remain Mom-and-Pop companies, so too are there firms that would appear to be Mom-and-Pops on a revenue basis that in fact should be considered Middle Market firms, based on their business prospects and scalability. For example, I have participated in the sale of several businesses generating less than $1 million in annual revenues that sold for more than $20 million. Such firms are recognized easily, based on “killer app” goods and/or services and on their scalability and future prospects. They often are either growing very rapidly or have the potential to do so. Frequently, they are technology businesses that have something very special to offer both their current clients and the strategic buyers that compete aggressively to acquire them.

Brokers and Investment Bankers Servicing the Three Markets

Middle Market investment bankers quite understandably are more interested in a business’s likely market value than its revenues when determining whether or not to represent a prospective client. Their fees ultimately will be reflect the selling price of the business. At a bare minimum, most serious Middle Market investment banks would have a substantial retainer and a minimum fee of $200,000, and would expect a prospective client to be worth at the very least $3 to $4 million in the marketplace and be attractive to serious strategic buyers before agreeing to represent it, leaving businesses of lesser value to business brokers, consultants, and, not infrequently, freelancing accountants.

More akin to residential real estate agents, business brokers usually operate as relatively nontechnical “matchmakers,” marketing their clients through newspaper classified advertisements, online advertisements, and tabloid-type catalogues of “businesses for sale.” They typically charge fees of around 10% of the transaction values (which are usually under $1 million) and mostly operate with no retainer. Business brokers do provide Mom-and-Pop firms with valuable, if somewhat nontechnical, support. Unlike investment bankers, who usually focus more on sellers than on buyers (strategic and financial buyers can be easily identified, once a sales side client has been engaged an investment banker), business brokers tend to develop stables of (usually individual or similar smaller business) buyers to whom they present their new sales “listings.”

Finally Wall Street and/or major regional investment banks serve the Upper Market by providing services in support of mergers and acquisitions of large companies, divestitures, and leveraged buyouts, among other transactions including initial public offerings (IPOs) of stock.

Chapter Highlights

• The Middle Market has been described in various ways by different authors and organizations, but a good definition would be businesses having from $2 million to $500 million in revenues.

• At its broadest definitional limits, Middle Market firms generate from $4 million to $1 billion in annual revenues, so for all practical estimation purposes, Middle Market firms so defined generate from $2 million and $500 million in business value.

• The Middle Market represents approximately 21% of U.S. businesses, while Mom-and-Pop firms (often lifestyle businesses for which formal financial theory valuations seldom are relevant or applicable) account for 79% of businesses. Upper Market firms account for the remaining less than 1%.

EXHIBIT 1.1 The M&A Process from Start to Finish

• Mom-and-Pops are sold with the assistance of business brokers who develop stables of buyers for these smaller firms.

• Sales of Middle Market and Upper Market firms are transacted by boutique or large investment banks.

• Middle Market businesses are usually represented by investment bankers who are more concerned with sellers, inasmuch as buyers for these attractive business are usually not that difficult to locate.

Exhibit 1.1 gives an overview of the M&A process.

Notes

1 In point of fact, there is really no consensus agreement on where the Middle Market ends and the Upper Market begins. I do not think anyone would argue though with an upper limit on the former of $1 billion in sales (which in turn suggests about $500 million in value). As a practical matter between $500 million in value and $1 billion is a rarified area and most Middle Market transactions in the M&A world are substantially under even $500 million in value.

2 This excludes some 17,600,000 “businesses” that have no employees.

3 For a basis for this assumption, see Chapter 23, the Rules of Five and Ten.

CHAPTER 2

Drivers of Middle Market Activity and the Sellers

Liquidity and Umbrella Drinks

In the first decade of the 21st century, Middle Market mergers and acquisitions (M&A) activity is driven by several unique factors, some old but many of them new. The first is liquidity. Many attractive Middle Market businesses have ten or fewer owners. Precisely because Middle Market firms have so few principal shareholders, they often find themselves up for sale when liquidity issues arise. For example, one or more owners may wish to leave the business to happily retire (I like to call them “umbrella-drink sellers”), or may need to exit due to other lifestyle issues. Health issues, divorce, and death among the principal owners’ group may lead to a sale if the owner’s heirs or partners cannot accommodate each others’ needs. Selling a partial interest in a Middle Market business is not as easy as selling a partial interest in a public company, where ordinarily, a simple call to your stock broker will do the trick. If the interest is big enough, it may result in having to put the whole company, not just the partial interest, on the market. Of course, in a case where the liquidity problem (or just the desire for liquidity) is with one of the majority owners, it will almost certainly result in a sale if there are no other options—and frequently there are not.

Baby Boomers

There are also the ubiquitous baby boomers, no less a driving force in Middle Market M&A than in all other aspects of life in the late 20th and early 21st centuries. The eldest members of the 78-million-strong baby boom generation turned 60 in 2006. The youngest boomers will turn 66 (our government’s estimate for the most common retirement age) in 2030, about 22 years from now. Many baby boomer entrepreneurs will sell the Middle Market businesses they founded, and this factor will remain a major driving force in M&A for at least two more decades. To put this transaction data into perspective, consider this: Based on data supplied by the U.S. Census Bureau in 2002 there are just about 1.2 million Middle Market firms with sales of $1 million to $1 billion annually. Collectively, these 1.2 million firms had sales totaling $9.8 trillion and carry a conservative market value of $4.9. And the boomers own about 800 thousand of these businesses. Between 2011 and 2029 (19 years) an average of 43 thousand of these a year will be disposed of, about 2/3 of these by sale. These are huge numbers and unprecedented.

Technology and the Information Age

This is not your mother’s Middle Market. Technological advances have dramatically transformed the Middle Market of 2008 from that of 1966. Consider that the first widespread use of the Internet was in 1995. Consider that the amount of technical information in the world doubles every 24 months. Well known as “Moore’s Law.”

Today, many Middle Market firms will have dramatically shortened business life cycles as new technologies are developed and adapted throughout the global economy. New technologies and approaches launched by Middle Market firms routinely disrupt and eclipse other Middle Market—even Upper Market—firms, and sometimes entire industries. Light-speed advancement in disruptive technologies is the rule, forcing survivors to become increasingly more proactive and infinitely more responsive vis-à-vis their clients and prospects . . . or die. Middle Market firms that rest on their laurels, growing complacent with past achievements, will, not may, wake up one day soon to find themselves in the “buggy whip business,” figuratively speaking.

Creative destruction always has been a force to be reckoned with in capitalist systems. It existed in the United States in 1908 and 1808. But in 2006, the ever-increasing speed of technological advances has accelerated the process to an astonishing degree. As a result, business life cycles (or at least “business as normal” life cycles) have been truncated no less dramatically among businesses that rely on technology than among those that develop technologies. Ten years ago, the Internet was effectively in its infancy for the vast majority of the world. Since then, the Internet has radically transformed our world, our economy, and virtually every business in the United States and elsewhere. A good illustration of this is that the average existence of a company in the Standard & Poor’s (S&P) 500 index, which shows that annual turnover 50 years ago was 25 to 35 years, versus today’s 12 to 14 years.

The Middle Market business life cycle—the time elapsed from founding to exiting, or at least to growing by acquisitions of other Middle Market business—has gone from 25 years or more, historically, to 2 to 5 years in and even less in some technology or technology-dependent businesses, with most of that acceleration being realized in the last ten years. The radical shortening of business life cycles, in turn, has had an enormous impact not only on Middle Market business operations but also on the timing, frequency and execution of the sale of Middle Market firms as well.

It’s Not Your Father’s M&A World, Either

McLean, VA—April 2006,

I looked around the large meeting room, rehearsing in my mind some brief remarks to introduce the panel of experts that would discuss business and M&A transactions with India. I was not sure whether it would be taken as offensive or humorous, but my temptation was to make a comment somewhat along the lines that when I was 12 years old (53 years ago admittedly), the breadth of my knowledge of India was more or less covered by Rudyard Kipling’s famous British Empire novels, and that it would be in fact another 40 (circa 2000) years before my awareness of India had much improved, at least in terms of doing business with it. My god I can barely believe how small the world has become in terms of commerce in the last ten years.