Practitioner's Complete Guide to M&As E-Book

David T. Emott

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Editions
• Sprache: Englisch

Seitenzahl: 583

Veröffentlichungsjahr: 2011

Beschreibung

The ultimate guide to the ins and out of mergers and acquisitions

Practitioner's Complete Guide to M&As provides the practical tricks of the trade on M&As: what they need to know, what they have to know, and what they need to do. Numerous examples and forms are included illustrating concepts in discussion.

• Written in a straight-talking style
• A highly, practical application-oriented guide to mergers and acquisitions
• Covers strategy development; deal flow and target identification; due diligence; valuation and offers; tax structuring; negotiation; and integration and value creation"
• Presents information using bullet points rather than lengthy narrative for ease of reading
• Numerous exhibits, forms, and examples are included

This practical guide takes you through every step of the M&A process, providing all the necessary tools that both the first-time M&A player as well as the seasoned practitioner need to complete a smart transaction.

Leseprobe

Contents

Cover

Series

Title Page

Copyright

Preface

Acknowledgments

Topic 1: Strategy Development, Then M&A

M&A IS ONE OF MANY BUSINESS DEVELOPMENT OPTIONS

STAGES INVOLVED IN THE STRATEGIC PLANNING PROCESS

STRATEGY DEVELOPMENT—WHERE AND HOW TO CREATE VALUE

WHERE—IDENTIFY CUSTOMER'S INITIATIVES AND ATTRACTIVE MARKET SPACES

HOW—IDENTIFY YOUR ACTIVITIES AND CAPABILITIES—EXTEND THEM

HOW—IDENTIFY YOUR CAPABILITY GAPS VS. MARKET AND PRODUCT REQUIREMENTS

HOW—IDENTIFY YOUR CAPABILITY GAPS VS. COMPETITION

HOW—DEFINE ATTRACTIVE MARKET CRITERIA, RATE MARKETS, CLOSE GAPS

HOW—IF M&A IS VEHICLE TO CLOSE GAPS, IDENTIFY TARGETS

Topic 2: M&A Process: Front to Back

DEFINITION OF THE M&A PROCESS

Topic 3: Why M&A?

DEFINE THE ROLE AND GOAL FOR M&A

LOOK FOR CAPABILITY OVERLAPS WITH TARGETS TO BALANCE ACQUISITION RISK

Topic 4: Deal Criteria

DEAL CRITERIA DEVELOPMENT

CRITERIA RATING ENGINE

CONCLUSION TO THE CRITERIA RATING ENGINE

WHERE DOES TARGET FALL ON COMPETITIVE CONTINUUM?

Topic 5: Deal Sourcing

POTENTIAL SOURCES, PROS AND CONS

Topic 6: Fees for Services

OVERVIEW

FEE STRUCTURES: AN OVERVIEW

BUY-SIDE BANKER FEE ARRANGEMENTS

BUY-SIDE BANKER FEE ILLUSTRATION

Topic 7: Financial and Strategic Buyers

FINANCIAL BUYERS

STRATEGIC BUYERS

Topic 8: How Long Will It Take to Complete the Deal?

DEAL ISSUES TAKE TIME

Topic 9: Confidentiality Agreements

ENTER INTO CONFIDENTIALITY AGREEMENTS EARLY

DISCUSSION BETWEEN COMPETITORS REQUIRES GREAT CARE

USE A FIREWALL

Topic 10: “Concern Capture” Due Diligence

DESCRIPTION OF THE DUE DILIGENCE PROCESS

PHASE ONE: PRELIMINARY DILIGENCE

PHASE TWO: DETAIL DUE DILIGENCE

IDENTIFY NON-NORMATIVE TRENDS AND BEHAVIOR

BUSINESS DRIVER ASSESSMENT ENGINE—DETERMINE STRENGTH OF INCOME DRIVERS

VALUATION DRIVER ASSESSMENT ENGINE-DETERMINE STRENGTH OF VALUATION DRIVERS

CONCLUSION

Topic 11: Keep Deal Conversations Quiet

WHAT TO DO WHEN IT LEAKS OUT

Topic 12: Auctions

FEAR IS A COMPELLING DRIVER TO AUCTION SUCCESS

AUCTION PROCESS—BID SOLICITATION

AUCTION PROCESS—INVITATION TO BID

AUCTION PROCESS—FIRST ROUND CONDITIONAL OFFER

AUCTION PROCESS—MANAGEMENT PRESENTATION, DUE DILIGENCE, MORE BID ROUNDS

AUCTION PROCESS—SELECT A WINNER

PREEMPTIVE OFFERS

AUCTION PROCESS—GRANT EXCLUSIVITY

FAILED AUCTIONS

AN AUCTION BIDDING STRATEGY

BEWARE OF THE CRAZIES

Topic 13: Seller's Prospectus

CONTENTS OF THE SELLING DOCUMENT

Topic 14: Pay for Inherent Capabilities Only

THE BASKET OF CAPABILTIES ACQUIRED HAS A FINITE LIFE AND VALUE

SELLER PROJECTIONS OFTEN COMINGLE CURRENT AND FUTURE CAPABILITIES

PAY ONLY FOR EXISTING VALUE POTENTIAL

Topic 15: Platform Value

WHAT IS IT, HOW MUCH IS IT WORTH

THE REAL OPTION APPROACH TO PLATFORM VALUATION

Topic 16: Buyer and Seller Value Perspectives

WHAT IS THE OTHER SIDE THINKING THE VALUE OF THE BUSINESS IS?

Topic 17: Integration Initiatives Will Determine Deal Value

KNOW WHAT YOU ARE GOING TO DO TO CREATE ADDED VALUE IN YOUR DEAL

Topic 18: Unlock Hidden Value: The Lean Enterprise

EVALUATE LEAN OPPORTUNITIES DURING DUE DILIGENCE

STAPLE YOURSELF TO AN ORDER

CONCLUSION

Topic 19: The Real Deal: Lean

LEAN ENTERPRISE OVERVIEW: IDENTIFY THE NON-VALUE-ADDED ACTIVITIES

ONE-PIECE FLOW IS THE GOAL

CONCLUSION

Topic 20: Valuation: An Introduction

VALUATION CONSIDERATIONS AND METHODS OVERVIEW

COMPARABLE METHODS: MARKET APPROACH OVERVIEW

CAPITALIZATION OF BENEFITS METHOD OVERVIEW

DISCOUNTED CASH FLOW METHOD

Topic 21: Discounted Cash Flow: An Introduction

DCF—INTRODUCTION, ADVANTAGE, DISADVANTAGE

COMPOUNDING

DISCOUNTING

DISCOUNTED CASH FLOW

Topic 22: Free Cash Flow

FCF DEFINED

FCF DETERMINATION

WHILE THE ELEMENTS OF FCF ARE SOMETIMES RESTATED TO MEASURE ROI, THERE IS NO EFFECT ON FCF

CONCLUSION

Topic 23: Fair Return on a Deal

FAIR RETURN

CAPITAL ASSET PRICING MODEL

SECURITY MARKET LINE

COSTS OF CAPITAL DEFINED AND USES: CU, CL, I, AND C*

VALUATION RISKS

OTHER METHODS OF RETURN ON EQUITY ESTIMATION

CAPM CALCULATION

TREATMENT OF INHERENT VOLATILITY FROM UNSYSTEMATIC RISK IN VALUATIONS

INTERNATIONAL COST OF EQUITY CAPITAL—OVERVIEW

Topic 24: Risk-Free Rates

RISK-FREE RATE DEFINED

Topic 25: Equity Risk Premiums

EQUITY RISK PREMIUM DEFINED

Topic 26: What Is Business Risk?

BUSINESS RISK IN M&A DEFINED

CONTROL AND RISK MANAGEMENT EMANATES FROM KNOWLEDGE OVERLAPS

Topic 27: Entropy: Tendency toward Negative Variation

ENTROPY DEFINED

ENTROPY IN M&A DEALS

Topic 28: Equity Investor Risk

OVERVIEW

Topic 29: Beta

BETA IS AND IS NOT

DEBATE OVER BETA

Topic 30: Systematic Risk

SYSTEMATIC RISK DEFINED

Topic 31: Unsystematic Risk

UNSYSTEMATIC RISK DEFINED

Topic 32: Beta with or without Debt

OVERVIEW

Topic 33: Beta: Levered or Unlevered

GATHERING APPLICABLE AND COMPARABLE BETAS

DELEVERAGING LEVERED BETAS AND DEVELOPING A COMPARABLE UNLEVERED BETA FOR THE TARGET

TO RELEVER AN UNLEVERED ASSET BETA

Topic 34: Beta Application in Determination of CU

Topic 35: Levered Beta Moves as Debt to Equity Moves

LEVERED BETA IN A WORLD WITHOUT TAXES

LEVERED BETA IN A WORLD WITH TAXES

Topic 36: Size Premium

SIZE PREMIUMS ARE INVERSELY RELATED TO FIRM SIZE

Topic 37: Weighted Average Cost of Capital

INTRODUCTION TO WEIGHTED AVERAGE COST OF CAPITAL

WEIGHTED AVERAGE METHOD OF C* DETERMINATION

DIRECT METHOD OF C* DETERMINATION

ADJUSTED DIRECT METHOD OF C* DETERMINATION

Topic 38: Terminal Values, Terminal Value Multiples, and Terminal Value DCFs

TERMINAL VALUE DEFINITION

OVERSTATING TERMINAL VALUES IS A DEAL VALUATION RISK

TERMINAL VALUE DETERMINATION METHODS

PERPETUITY GROWTH CAPITALIZATION METHOD

DISCOUNTED FREE CASH FLOW INTO PERPETUITY METHOD

DISCOUNTING THE TERMINAL VALUE AMOUNT AT THE END OF YEAR T

LIQUIDATION OF ASSETS TERMINAL VALUE METHOD

Topic 39: Discounted Cash Flow Valuation Illustrated

DCF VALUATION PROCESS

OFFER DETERMINATION PROCESS

Topic 40: Leverage: The Real Deal

LEVERAGE INCREASES DEAL VALUATIONS

CONCLUSION

Topic 41: Debt Limits

THE PRACTICAL LENDING LIMIT IS UP TO LENDERS

Topic 42: Debt Adds Value: The Derivation of Dt

DERIVATION OF DT AND TAX ADVANTAGE OF A FIXED LEVEL OF DEBT

TAX ADVANTAGE OF DEBT WITH A VARYING LEVEL OF DEBT

DEBT ADVANTAGE IN M&A TRANSACTIONS

Topic 43: The Leveraged Buyout; Definition and Valuation

LBO DEFINED

LBO VALUATION OVERVIEW

DEBT LEVELS EMPLOYED

RECAPITALIZATIONS AND EQUITY INVESTORS’ END GAME

LEVERAGED BUYOUT CAPITAL STRUCTURE AND COMPANY CHARACTERISTICS

Topic 44: Valuing the Leveraged Buyout

STEPS TO VALUE THE LBO

STEPS TO DETERMINE LBO OFFER

BENEFIT OF USING DEBT VERSUS NO DEBT ON ENTERPRISE VALUE AND OFFERS

LBO OFFERS EQUAL THE EQUITY INVESTED PLUS THE DEBT

FINAL NOTE ON THE VALUE PAID IN LEVERAGED BUYOUTS

Topic 45: Real Option Valuation: An Introduction

DEFINITION AND DEEPER VALUE OF REAL OPTIONS

REAL OPTIONS VALUATION AND DISCOUNTED CASH FLOW VALUATION

UNDERSTANDING THE RESULT FROM A REAL OPTION VALUATION

FORMS OF REAL OPTIONS AND VALUATION DETERMINATION METHODS

REAL OPTION APPLICATIONS IN M&A

Topic 46: Real Option Valuation: Application and Illustration

OVERVIEW

REAL OPTION VALUATION: AN EXAMPLE

NPV APPROACH

ILLUSTRATION OF ELEMENTS OF REAL OPTION APPROACH

INTERPRETATION OF THE REAL OPTION RESULT

USING THE MODIFIED BLACK-SCHOLES REAL OPTION MODEL

REVIEW THE TOLLING ARRANGEMENT AND OPTION VALUE AT THE END OF THE FIRST YEAR: IF LOWER VOLATILITY IS EXPECTED

REVIEW THE TOLLING ARRANGEMENT AND OPTION VALUE AT THE END OF THE FIRST YEAR: IF HIGHER VOLATILITY IS EXPECTED

CONCLUDING REMARKS ON REAL OPTION VALUATION

Topic 47: M&A Values Are Not All the Same

INVESTMENT VALUE

CONTROL VALUE

FAIR MARKET VALUE

ENTERPRISE VALUE

EQUITY VALUE

MINORITY VALUE

OFFER VALUE

TRANSACTION VALUE

NET REALIZED SELLER VALUE

Topic 48: Discounts and Premiums

ACQUISITION PREMIUMS

CONTROL PREMIUMS

MINORITY DISCOUNTS

MARKETABILITY (OR LIQUIDITY) DISCOUNTS

KEY MAN DISCOUNTS

CONGLOMERATE DISCOUNTS

FUZZY LOGIC BETWEEN DISCOUNTS AND VALUATION LEVELS EXAMPLE

Topic 49: Discounted Cash Flow Valuations: Minority or Control

DCF VALUATIONS

DCF VALUATIONS OF PRIVATELY HELD COMPANIES IN ACQUISITIONS

Topic 50: Inflation in DCF Valuations

INCLUDE INFLATION IMPACTS IN DCF VALUATION

Topic 51: Integration, Alignment, and Synergy Benefits: Plan It Out

THE STEPS TO DEVELOP THE INTEGRATION PLAN

Topic 52: Integration, Alignment, and Valuing Synergy Benefits

INTRODUCTION-INTEGRATION PLANNING, SYNERGY EVALUATION

KEY SUBJECT AREAS REQUIRING ATTENTION

STRATEGY ALIGNMENT, DEVELOPMENT, AND BUY-IN

ORGANIZATIONAL DESIGN, MANAGEMENT, CULTURE, AND POLICY

COMMUNICATION

CAPACITY, R&D PROJECT, AND FACILITY SELECTION DESIGN

OTHER FACILITY SYNERGY DESIGN

BUSINESS AND SUPPORT FUNCTION SYNERGY DESIGN

MARKET, CUSTOMER-BASED SYNERGIES

TECHNOLOGY, INTELLECTUAL PROPERTY, AND R&D

INFORMATION TECHNOLOGY

Topic 53: Venture Capital Valuation

VC INVESTOR INTERESTS, RETURN TARGETS: AN EXAMPLE

Topic 54: Discount Rates and Valuing Free Cash Flow

OVERVIEW

YEAR-END DISCOUNT RATES

BEGINNING-OF-YEAR DISCOUNT RATES

MIDYEAR DISCOUNT RATES

QUARTERLY DISCOUNT RATES

MONTHLY DISCOUNT RATES

DAILY DISCOUNT RATES

CONTINUOUS DISCOUNT RATES

SUMMARY

Topic 55: Growth, C*, and Return: The Engine to Increased Valuations and Deferred Tax Advantage

INTERDEPENDENCIES AMONG GROWTH, RATE OF RETURN, AND COST OF CAPITAL

GROWTH ALSO CREATES A POTENTIAL DEFERRED TAX OPPORTUNITY

Topic 56: How Fast Can the Target Grow?

Topic 57: Cash Flow Multiples, Growth Rates, and Discount Rates

LAGGING FREE CASH FLOW MULTIPLES, END-OF-YEAR BASIS, NO GROWTH

LAGGING FREE CASH FLOW MULTIPLES, MIDYEAR BASIS, NO GROWTH

FACTOR TO CONVERT END-OF-YEAR BASIS MULTIPLES TO MIDYEAR'S BASIS

LAGGING FREE CASH FLOW MULTIPLES, END-OF-YEAR BASIS, WITH GROWTH

DISCOUNTED RATE ADJUSTED GROWTH RATE METHOD TO DETERMINE FCFM

DERIVATION OF GD IN THE DISCOUNTED RATE ADJUSTED GROWTH RATE METHOD

METHOD FOR DETERMINING AN APPROXIMATION OF GD AND FCFM

IMPACT OF NOT USING GD IN FCFM MULTIPLE CONSTRUCTION

DERIVE FCFM, C*, OR GD FROM EITHER OF THE OTHER TWO TERMS

SPIDER CHART METHOD FOR VISUAL EXPLANATION OF THE CONSTRUCTION OF C* AND FCFM

DERIVATION OF PRICE EARNINGS AND OTHER MULTIPLES FROM FCFM

Topic 58: Comparable Multiples

“COMPARABLE” MULTIPLES ARE NOT COMPARABLE UNTIL THEY ARE ADJUSTED

“COMPARABLE” MULTIPLE ADJUSTMENT PROCESS

DEVELOP COMPONENT RECONCILIATION OF COMPARABLE COMPANY TO TARGET FCFM

CONCLUSION

USE OF THE ADJUSTED FCFM

Topic 59: Converting FCFM to P/Es and Other Valuation Multiples and Deriving Slot Multiples for Public Companies

UNDERSTAND THE SUSTAINABLE RELATIONSHIPS BETWEEN FCF AND OTHER EARNINGS FUNDAMENTALS

DERIVATION FORMULA TO CONVERT FROM FCFM TO OTHER VALUATION MULTIPLES AND VICE VERSA

VISUAL CONVERSION OF FCFM TO EBITDAM

USE THE P/E EVISCERATOR TO VALIDATE P/E TRADING MULTIPLES OF PUBLIC COMPANIES

P/E EVISCERATOR APPLIED TO THE ILLUSTRATION IN TOPIC 60

P/E EVISCERATOR APPLIED TO COCA-COLA COMPANY AS OF OCTOBER 31, 2007

IMPLICIT PE, FCFM VERSUS DERIVED SLOT P/E, FCFM, AND GD

VARIANCE IN SLOT RESULTS IF ASSUMPTIONS ARE SENSITIZED

CONCLUSION ON KO P/E

THE VALUE-CREATION POTENTIAL INDEX FOR KO

P/E EVISCERATOR APPLIED TO GOOGLE INC. AS OF NOVEMBER 1, 2007

IMPLICIT P/E, FCFM VERSUS DERIVED SLOT P/E, FCFM, AND GD

VARIANCE IN SLOT RESULTS IF ASSUMPTIONS ARE SENSITIZED

CONCLUSION ON GOOG P/E

THE VALUE CREATION STRENGTH INDEX FOR GOOG

CONCLUSION: P/E EVISCERATOR

GRAPHS OF APPROXIMATE SMALL- AND LARGE-COMPANY FREE CASH FLOW AND EBITDA MULTIPLES OVER A RANGE OF GROWTH

Topic 60: EBITDA Valuation Engine

EBITDA ENGINE OVERVIEW—A SHORTHAND VALUATION METHOD

EBITDA ENGINE EXPLAINED

VALUE OF GROWTH DURING T

EBITDA ENGINE VALUATION EXAMPLE

COMPARISON OF EBITDA ENGINE VALUATION RESULTS WITH OTHER METHODS

SPIDER CHART PRESENTATION OF THE EBITDA ENGINE ILLUSTRATION OF APPENDIX 60.2

A FINAL NOTE ON VALUATIONS

Topic 61: Free Cash Flow Equivalent Impacts for Arbitrary Adjustments to Discount Rates

ARBITRARY ADJUSTMENTS DISCUSSION

Topic 62: Transferring Defined Benefit Pension Plan Liability Issues

INTRODUCTION

BUYER'S VALUATION OF PENSION LIABILITY

PROJECTED BENEFIT OBLIGATION BASIS FOR LIABILITY VALUATION

ACCUMULATED BENEFIT OBLIGATION BASIS FOR LIABILITY VALUATION

PROJECTED TERMINATION BASIS FOR LIABILITY VALUATION

SELLER'S VALUATION OF PENSION LIABILITY

GOING-CONCERN BASIS FOR LIABILITY VALUATION

NEGOTIATED VALUATION OF PENSION LIABILITY

PENSION ASSET TRANSFER ISSUES

BENEFIT TRANSFER ISSUES

Topic 63: Environmental Remediation Expenses

OVERVIEW

Topic 64: Environmental Insurance

GENERAL TERMS OF ENVIRONMENTAL INSURANCE

POLLUTION LEGAL LIABILITY INSURANCE

IF BUYER ACQUIRES AN ACTIVE KNOWN ENVIRONMENTAL ISSUE

Topic 65: Management Warrant Incentive Plans

MANAGEMENT WARRANT INCENTIVE PLAN DESCRIPTION

WARRANT PLAN ILLUSTRATION

Topic 66: Negotiation: Introduction and Overview

OVERVIEW OF NEGOTIATION CONSIDERATIONS AND CONDUCT GUIDELINES

Topic 67: Negotiation: Values, Offers, Prices, and Risk Assumption

DRIVERS OF THE DESIRED AND ACCEPTABLE TOTAL CONSIDERATION FRONTIER

DRIVERS OF THE ACTUAL TOTAL CONSIDERATION FRONTIER

Topic 68: Negotiation: Offer Content

THE COMPLETE OFFER: KNOW WHERE YOU WANT TO END UP BEFORE YOU GET STARTED

Topic 69: Negotiation: Create Space in Your Ideas

OVERVIEW

Topic 70: Negotiation: Beware of the Emotions of Private Sellers

OVERVIEW

Topic 71: Negotiation: Imprint; Do Not Lecture

IMPRINT, CAREFULLY

Topic 72: Negotiation: Handling Tight Spots

A PRIMER ON HANDLING TIGHT SPOTS

Topic 73: Negotiation: Closing the Bid-Ask Negotiating Gap

MANAGING AND WORKING THROUGH THE GAP

WALK OUT IF NECESSARY, BUT KEEP TALKING

CONTRACTUAL CONDITIONS APPORTION FINAL RISK POSITIONS—WORK THEM HARD DURING NEGOTIATIONS

Topic 74: Negotiation: Be Aware of Leverage and Deal Momentum Shift

LEVERAGE: IF YOU HAVE IT, USE IT (APPROPRIATELY)

BEWARE OF EXTORTION

DEAL MOMENTUM SHIFTS AS A DEAL PROGRESSES

Topic 75: Negotiation in the Final Stages

THE LOBBED OFFER STAGE

STEP BACK WHEN YOU ARE READY TO SHAKE HANDS

Topic 76: Negotiation: Use Earn-Outs or Noncompete Agreements to Close a Bid-Ask Gap

WHY DO AN EARN-OUT?

EARN-OUT PERFORMANCE PAYMENTS

TAX CONSIDERATIONS OF EARN-OUTS

AN EARN-OUT EXAMPLE

EARN-OUT CONCLUSION

NONCOMPETE AND CONSULTING AGREEMENTS

Topic 77: Negotiation: After the Deal Is Agreed

HEADS OF AGREEMENT AND WHAT TO INCLUDE IN IT

Topic 78: Negotiation: Bluffing and How to Handle It

THE FOUR COURSES OF ACTION WHEN YOUR BLUFF IS CALLED

ROLL OVER

NO WAY, BUT

YOU TALKING TO ME?

BLUFF AND TURN

Topic 79: Negotiation: When Do You Step Away?

FOR BUYERS

FOR SELLERS

Topic 80: Negotiation: When Do You Proceed?

FOR BUYERS

FOR SELLERS

Topic 81: Negotiation: Do a Time Capsule

THE TIME CAPSULE

Topic 82: Negotiation: Build Trust to Get Closed

HOW TO CREATE TRUST

LET YOUR NEGOTIATING BEHAVIOR BE GUIDED BY YOUR DAILY SPIRITUAL NEEDS

HOW TO HANDLE THE BULLY

Topic 83: Exits under Duress: Have a Plan if the Deal Does Not Work

HAVE AN EXIT PLAN

Topic 84: Structuring the Deal: An Overview

DEAL STRUCTURES AND LEGAL AND TAX IMPLICATIONS

FRONTIERS OF TRANSACTION ACCEPTANCE

DEAL-STRUCTURING CONSIDERATIONS AND TRADE-OFF OPTIONS

GENERAL TAX CONSEQUENCES ASSOCIATED WITH DEAL-RELATED EXPENSES

CONTRACTUAL CONDITIONS LIMIT AND APPORTION FINAL RISK ASSUMPTION POSITIONS—WORK THEM

Topic 85: Structuring the Deal: Asset Step-Ups, Noncompete, and Synergy Valuation Engines

VALUATION OF ASSET TAX BASIS STEP-UPS

FIXED ASSET STEP-UP VALUATION

INVENTORY STEP-UP VALUATION

NONCOMPETE VALUATION

SYNERGY VALUATION

SYNERGY VALUATION USING THE REAL OPTION MODEL

Topic 86: Total Shareholder Return

TOTAL SHAREHOLDER RETURN DEFINED

CALCULATION OF TSR

Topic 87: Stakeholder Value Creation

SATISFY THE CUSTOMER AND EMPLOYEES

SATISFY THE SHAREHOLDER THROUGH VALUE CREATION

Topic 88: EVAquity: Align Shareholder and Management Interests

EVAQUITY INCENTIVE PLAN OVERVIEW

EVAQUITY PLAN TERMS

EVAQUITY PLAN EXAMPLE: PROSPECTIVE PLAN

EVAQUITY PLAN EXAMPLE: AFTER TWO YEARS’ ACTUAL RESULTS

Topic 89: Letter of Intent

INTRODUCTION TO THE LOI

Topic 90: Purchase and Sale Agreement

INTRODUCTION TO THE PSA

Topic 91: Purchase and Sale Agreement: Explanation by Section

PARTIES, DEFINITIONS, PURCHASE, AND SALE

PURCHASE PRICE AND ADJUSTMENTS, COVENANTS PRIOR TO CLOSING

REPRESENTATIONS AND WARRANTIES OF THE SELLER, INTRODUCTION

REPRESENTATIONS AND WARRANTIES OF THE SELLER

REPRESENTATIONS AND WARRANTIES OF THE BUYER

CONDITIONS TO CLOSING, CLOSING AND DELIVERIES AT THE CLOSING

POSTCLOSING COVENANTS, INDEMNIFICATION, SURVIVAL OF REPRESENTATIONS, AND WARRANTIES

INDEMNIFICATION PROCEDURE

OTHER PROVISIONS

Topic 92: Purchase Price Adjustments for Working Capital

TARGET AND ACTUAL WORKING CAPITAL DETERMINATION

THE CLOSING WORKING CAPITAL ADJUSTMENT—A ZERO-SUM EVENT

SOMETIMES THE WORKING CAPITAL ADJUSTMENT IS NOT A ZERO-SUM EVENT

WORKING CAPITAL COLLARS

Topic 93: Indemnification and Survival Provisions

INTRODUCTION

INDEMNITY PROVISIONS, CAPS, BASKETS, DURATIONS

USE A MATRIX TO SORT OUT INDEMNITY PROVISIONS

CONTRACTUAL CONDITIONS APPORTION FINAL RISK POSITIONS—WORK THEM HARD DURING NEGOTIATIONS

Topic 94: Escrows

INTRODUCTION

Topic 95: Joint Venture Transaction: Valuation and Structuring Overview

WHY DO A JOINT VENTURE

WHO CONTROLS THE JOINT VENTURE

LETTER OF INTENT AND PARTNERSHIP AGREEMENT

JV FORMATION AGREEMENT

TECHNOLOGY LICENSE AGREEMENTS

SUPPLY AGREEMENTS

DISTRIBUTION AGREEMENTS

OTHER AGREEMENTS

JV VALUATION AND SHAREHOLDER EQUITY CONTRIBUTION TO THE JV

Topic 96: Why Deals Go Bad

WHY DEALS GO BAD OR DO NOT WORK OUT

WHAT HAS TO HAPPEN TO AVOID BAD DEALS

Topic 97: After the Deal: Do a Deal Bible

DEAL BIBLE DEFINED

Topic 98: Do the Audits of the Integration and Deal Value Creation Plan

AUDIT THE INTEGRATION PLAN: ARE YOU GETTING THERE?

AUDIT THE DEAL VALUE CREATION: WHAT DID YOU LEARN?

About the Web Site

Index

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Copyright © 2011 by David T. Emott. 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:

Emott, David T., 1944– Practitioner’s complete guide to M&As : an all-inclusive reference / David T. Emott. p. cm. – (Wiley finance ; 635) Includes index. ISBN 978-0-470-92044-2 (pbk.); ISBN 978-1-118-01589-6 (ebk); ISBN 978-1-118-01590-2 (ebk); ISBN 978-1-118-01591-9 (ebk) 1. Consolidation and merger of corporations. I. Title. HD2746.5.E46 2011 658.1′62–dc22 2010045218

Preface

This book is a hands-on, practical guide and reference to the key topics, issues, and methodologies buyers and sellers face and employ in doing M&A (business mergers, acquisitions, divestitures, stock buybacks, equity investments, and joint venture transactions). It is a quick, easy-to-use reference for those new to the process of M&A (private business owners, students, associates, trainees). In addition, it will refresh and reacquaint those already familiar with deal making (CEOs, CFOs, lawyers, accountants, tax and finance, and insurance and deal professionals) with what happens, when, who is doing it, and why, and answer the question: What do we need to know and do at this phase of the process?

The book is written as a quick-read reference of ideas, approaches, and don’t-forgets for use during live transactions and as a self-study guide to enable fast transfer of essential M&A knowledge.

The topics in the book are laid out sequentially to enable the reader to build the highly relevant knowledge base necessary for pursuing and understanding corporate development via M&A. Topics covered including strategy development, acquisition criteria, deal sources, deal fee arrangements, due diligence, conducting auctions, lean enterprise, cost of capital, risk premiums, size premiums, leveraged and unleveraged beta, systematic and unsystematic risk, discount rate construction, valuation, pricing leveraged buyouts, the real deal about using debt, terminal values, real options in valuation, platform value, joint venture valuation and structuring, values, offers and deal pricing, discounts and premiums, venture capital valuation, growth, comparable pricing multiples, transferring pension obligations, deal integration, negotiation, risk and entropy, taxable and tax deferred deal structures, warrant- and economic value added– (EVA) based incentive plans, contracts and papering the deal, earn-outs, valuing synergies and tax step-ups, tax treatment of deal fees, escrows, caps, baskets, indemnity duration, why deals go bad, and much more.

Although some of the topics are longer than others, they all provide a succinct, pragmatic, and understandable view of each topic. The appendices referred to in each topic provide illustrations and visual guides that will prompt the reader to ask: How can this be adapted to work for us?

One of my goals when writing this book was to demonstrate the application of pertinent academic theory to the practical process of getting deals done. Sources in the footnotes and in the reference list direct the reader to additional information on the subjects discussed. It is my hope that the reader will view the book as a key reference when preparing for and undertaking the heady challenge of doing M&A. My aim is for the reader to finish a topic or the entire text with the feeling of “I get it.”

David T. Emott

Acknowledgments

I would like to thank many friends and associates who have contributed to the writing of this book.

Attorneys Lawrence Coassin, Mathew Guanci, John Lynch, and Richard Tomeo of Robinson & Cole, Hartford, Connecticut, provided invaluable assistance with the tax, deal structuring, negotiating, and contractual overview topics. This assistance was provided in the context of working many acquisitions and joint ventures together over the years as well as discussing and reviewing drafts of textual material. Working with John Stempeck, Partner, Avalon Associates, Boston, Massachusetts, provided valuable insight into the strategy and business development process.

I would also like to acknowledge the many individuals who encouraged me and allowed me to engage in the corporate development process while at The Dexter Corporation, where I cut my teeth on M&A transactions: David Coffin, Worth Loomis, Harold Fleming, and Bob McGill; and my associates in the trenches at The Dexter Corporation, John Vrabel, Dick Hurley, and Stiles Twitchell. Thanks also to my associates at Ensign Bickford Industries, who worked with me on many transactions and whose comments, work product, and insights contributed to and have found their way into the contents of this book: Herman Fonteyne, Joe Lovejoy, Ray Tremaglio, Dave Edwards, Tony Cicchetti, Jackie Levin, Bob Pallanck, Rick Roberts, Denise Grant, and Mike Long. Special thanks to my assistant while at Ensign Bickford Industries, Sue Mazurski, who prepared the first working draft of my manuscript from many handwritten pages prepared on my many flights to and from cities here and abroad as deals ran their course.

Thanks also to John Brzezenski, Partner, Avalon Associates, Boston, Massachusetts, who introduced me to Michael Frankel, Vice President Business Development and M&A, LexisNexis, New York City, who provided me with an introduction to Sheck Cho, my eventual Executive Editor at John Wiley & Sons. Thanks to Sheck and to Dexter Gasque, Senior Production Editor, at John Wiley & Sons for their encouragement and attention to detail as this book was prepared.

I should also acknowledge the many unnamed persons who sat across the table from me on many transactions here and abroad for their insights, offerings, and constant reminder that there is always a faster gun in town.

Lastly, thanks to my wife, Karen, who put up with me during the years of development of this book.

D. T. E.

Topic 1

Strategy Development, Then M&A

Topic 1 presents an overview of the fundamental elements typically addressed in the strategic planning process; explores a number of work activities, approaches, and ideas pertinent to the process of developing strategy; and explores where mergers and acquisitions (M&A) fit in the strategy development and execution process.

The reader is encouraged to take the time to read through the Appendices referenced in the text of this and all remaining Topics in conjunction with the narrative to gain the appropriate level of understanding of the subject matter discussed. Appendices are either presented at the end of this and each remaining Topic or are available for review and download on this book's companion Web site (see the About the Web Site page for login information).

M&A IS ONE OF MANY BUSINESS DEVELOPMENT OPTIONS

M&A in an operating business is one of a number of means to accomplish a strategic goal and generally results from a strategic planning and strategy development process.M&A activity is the strategic activity of investor groups (equity funds, venture capital funds, etc.).The work involved in strategy development in manufacturing or service firms is often found to be frustrating and difficult.The questions, introspective search, dialog, and answers often are time consuming and unclear, particularly to the operating executives doing this work who are used to dealing with issues and process refinements of running a business and making decisions.The operating executives include chief executive officers, chief financial officers, chief operating officers, operations directors, plant managers, manufacturing managers, chief marketing executives, or sales officers.The operating executives, however, are the source of the knowledge gained over years in the business that matters most in developing strategy.The work agenda must acknowledge early on that strategy development deals with issues and questions that do not have great clarity. The answers to these questions usually surrender not to analysis but to participants’ best thinking and judgment.The strategy development team should move along as fast as the pace of capturing and quantifying judgment allows and determine where complementary off-line research and analysis by the team and or team analysts is needed to enhance the judgment.Avoid a heavily research-driven process.

STAGES INVOLVED IN THE STRATEGIC PLANNING PROCESS

This section provides a general overview of the key elements of the strategic planning process usually employed in an operating company and indicates where M&A fits in. The information is presented in the Strategy Planning Process Engine in Appendix 1.1.

APPENDIX 1.1 Strategic Planning Process Engine: Core Essentials

Corporate vision embodies a brief, understandable, timeless statement of the rationale for why the firm exists (not what it does or wants to be) and the core principles that govern how the firm and its employees will conduct business and themselves during its existence.Corporate mission embodies a brief, understandable, realistic statement of what the firm wants to be (and be seen as) in the medium term, say 15 to 20 years.Corporate strategies are brief, understandable, achievable action statements of intent, direction, and desired result that are necessary to achieve and that, if achieved, will move the firm toward its mission (if not achieved, they will prevent achievement of the mission). These strategies are intended to create sustainable competitive advantage in the organization's market space. These strategies emanate from the strategy development process discussed later in this topic.Initiatives are big, achievable activities and programs that individuals and teams rally around and participate and take ownership in. Initiatives are necessary to complete and, if completed, will move the firm toward realization of the desired results embodied in each strategy. They are usually multiyear in duration. M&A is potentially one of a number of business development initiatives.Key performance indicators (KPIs) are descriptions of relevant, timeless indicators of performance in operating and functional support processes and initiative realization.Metrics are relevant, preferably quantitative measures by which to gauge performance toward and achievement of initiatives and of KPIs.Goals are brief statements of this year's (perhaps part of a multiyear goal) expected achievements and related metrics of achievement for each initiative or KPI. Goals are owned by individuals and teams and provide a clear measure of personal and team performance.Results are measurement based, integrate with incentive plan design and rewards, and provide the basis for measuring goal achievement and making cyclical, periodic adjustments to strategy, initiatives, metric targets, and goals.

STRATEGY DEVELOPMENT—WHERE AND HOW TO CREATE VALUE

The essential thrust of strategy development is identifying where to create value (attractive market spaces to enter or maintain and defend) and how to create value in the spaces selected. (What are the enabling capabilities and strategies required to close the capability gaps that exist for the firm to compete in the identified spaces and create enduring stakeholder value?)M&A is one of a number of means of closing the capability gaps. Other methods include organic development, in-house start-up, licensing, joint ventures, and other contractual arrangements.The process involved in detail strategy development usually includes the two steps noted above, which are shown in the Strategy Development and Gap Closure Engine in Appendix 1.2.

APPENDIX 1.2 Key Process Steps to Identify Where and How to Create Value and Close Strategic Gaps

Many of the process steps presented on Appendix 1.2 may not be carried out explicitly in reaching strategy conclusions in businesses that prefer a more intuitive strategy development approach, but they probably reflect the thought processes and trade-offs made by intuitive strategy developers.Do not underestimate what a highly skilled and experienced strategy development consultant can offer to drive the strategy development process. Experienced experts will, at the very least, provide a voice of reason, contrast, and clarity to the process. More often they will provide the results of external research and insights, options, points of focus, and direction, which are all of timeless value to the user.There is also great benefit to focus the due diligence process (normally applied to acquisition targets as discussed in Topic 10) internally (the firm's due diligence self-assessment) as part of the firm's strategic planning process. Doing so captures much of the knowledge of the firm's capabilities discussed later in this topic, as well as the business and valuation drivers discussed in Topic 10 and attractive market criteria discussed in Topic 4.

WHERE—IDENTIFY CUSTOMER'S INITIATIVES AND ATTRACTIVE MARKET SPACES

Identify your customer's (and your customer's customers) strategic initiatives in the market spaces you are now engaged in (See Appendix 1.2). Also identify their current and future product and service needs and requirements that will fulfill their initiatives (B, Appendix 1.2): By doing so, you can identify where are they going, what will they need to get there, and what is most important to them to enable them to succeed. You will also identify what capabilities will be necessary for vendors to excel at to meet their customers’ product and service requirements (B1, Appendix 1.2). Consider the following:Closely follow industry trends.Hold “customer futures” conferences for your industry and its future.Talk to your customers: How can you be in their future?Attend customer industry conferences and trade shows.Identify new attractive market spaces (B2, B3, Appendix 1.2) and the future product and service requirements of those spaces worthy of developing, entering, and defending (B, Appendix 1.2). Identify the capabilities necessary to meet those product and service requirements (B1, Appendix 1.2).Use brainstorming techniques to identify adjacent and new market space ideas. Cross-reference them to the results from these idea-generating methods: Search Web databases for ideas on where others are placing investments.Interview pension advisors and venture capital and equity investors for investment trends and developing sectors.Interview “blue sky” thinkers for megatrends and implications on business sectors.Perform top-down growth segment identification methods using macro, segment-oriented databases. Where is growth and investment occurring?Examine the value chains in growth sectors to identify the key value-creating enablers and inputs to the identified attractive macro sectors: What is the key ingredient, enabler, or activity in the value chain that adds the critical function to the end products and services within the sector?Identify the key value-added ingredient sector of the value chain that becomes the target market space in the attractive sector.Question industry experts to identify the value chain and enhance the analysis.Cross-correlate the findings from each method.Perform activity and capability extension analysis as discussed later in this topic.

HOW—IDENTIFY YOUR ACTIVITIES AND CAPABILITIES—EXTEND THEM

Identify your business's internal activity and capability strengths (Activities, Capabilities, and possibly Competencies) (C, Appendix 1.2).1Activities and capabilities are all the relevant things done in the business to serve customers in one way or another.Activities and capabilities as illustrated in Appendix 1.3 are evaluated in terms of how well they are done and the relative state of evolution of the activity within the company versus the requirements in targeted market spaces and as practiced by principal competitors. They are described as follows:

How Well the Activity Is Practiced in the Company

Leader or cutting edge; equal to or just okay; follower or lagging behind

State of Evolution of the Activity as Practiced in the Marketplace and as Required to Meet Future Market Requirements

Emerging, recently developed, gaining tractionRequired and undergoing changeMature, subject to competitive replacement

Activities and Capabilities Might Include, for Example

Conceiving, designing, assembling, fabricating, engineeringProposal preparation, selling, order taking, chemical synthesisMilling, cutting, folding, drawing, welding, bending, preparing, polishingField service, customer inventory management, distributing, deliveringSome activities may be competencies (see below)

Competencies Are the Reason(s) Customers Come Back

Competencies are the conjoint result of excellent business process execution (combinations of activities performed at a cutting-edge level) and deep capabilities described in terms of years of know-how, education, and unique learned and applied skills that are utilized in work activities.Competencies are observable and identifiable by customers as activities performed that they rely on most heavily and are not easily replicated by the competition.Bain & Company defines a core competency as a deep proficiency that enables a company to deliver unique value to customers. It embodies an organization's collective learning, particularly of how to coordinate diverse production skills and integrate multiple technologies.2Customer interviews asking why customers rely on you, buy from you, and keep coming back rather than going to the competition are often the most productive way to identify competence. Customers may say: “They always deliver on time in full quantities needed.”“Their product always functions to spec under the harshest use conditions.”“They can solve any technical design and application problem we throw at them and do it quickly.”“Their technical and delivery proposals to our conceptual requirements leave no questions unanswered—we know what we are going to get.”A company's competence is the conjoint process/capability set that leads to the end result desired and identified by the customer.Competencies allow a company to stay in business.There are many capabilities, business processes, activities, and skills; they are not necessarily competencies.There is usually only one competency in an organization, if any at all.

Activity and Capability Extension Analysis

Perform activity and capability extension analysis (D in Appendix 1.2) to identify adjacent market application potentials.3 Once you understand your key activity and capability strengths (perhaps competencies) as practiced in your segment, extend these activities into other potentially attractive segments.Ask key staff to examine where else (other served markets segments, other product or technical applications) your key activities and capabilities can be practiced, as illustrated in Appendix 1.4.Perform key word searches of your activities descriptors on databases to identify other “where used” potential market segments. Then analyze the segments to determine how attractive they are, who plays there, and how deep and how profitable the value chain in the sectors are (B2, B3, Appendix 1.2).

HOW—IDENTIFY YOUR CAPABILITY GAPS VS. MARKET AND PRODUCT REQUIREMENTS

Compare your existing company activities and capabilities (C, Appendix 1.2) with those required to defend present or develop or enter new attractive market spaces (B1).Identify your capability gaps (G) and consider alternative ways to close the gaps: M&A, joint venture, acquire or license technology, build a capability organically, etc. (see the Attractive Market Composite Assessment Engine in Appendix 1.5 for an illustration).Do you have what it takes to compete there? What capabilities do you need?

HOW—IDENTIFY YOUR CAPABILITY GAPS VS. COMPETITION

Compare your existing product and service offering strengths (E, Appendix 1.2) with existing competitor product and service offering strengths (E1) by conducting customer interviews and internal assessments. Identify product and service gaps (F) and possible gap closure approaches.Compare your existing company activities and capabilities (C, Appendix 1.2) with those of your competition (C1) in present and new attractive market spaces. Identify the competitive gaps (H): What does it take to meet or beat the competition and close the gaps? Identify possible gap closure approaches (see the Capabilities versus Competitive Assessment Engine in Appendix 1.6 for an illustration of this process). Are you better or worse than the competition? What capabilities do you need to improve?

HOW—DEFINE ATTRACTIVE MARKET CRITERIA, RATE MARKETS, CLOSE GAPS

Define attractive market criteria (I, Appendix 1.2), and measure and rate each market space identified against the criteria (see Topic 4 for an illustration of attractive market criteria). How well does each potential market stack up against your criteria for an attractive place to compete: well or not well? Do you want to be there or not?Perform a strategic option assessment (J, Appendix 1.2) of the capabilities that are required to defend, develop, enter, and exploit success and close gaps in each attractive market space.Identify the likely mode of closing the capabilities gap or achieving market penetration, such as in house start-up, acquisition, joint venture, technology license, and so forth (J1, Appendix 1.2).Rate the expected effectiveness of successful penetration into each new attractive market space, given each likely entry mode considered (K, Appendix 1.2) against the firm's key business investment success criteria, including, for example:Extent of activity overlap (Appendix 1.5)Level of difficulty (to enter, develop, defend) given the likely entry modeLevel of competitive risk (Appendix 1.6)Level of likely realization of opportunity potential given the likely entry modeAmount of time required to succeed given the likely entry modeLevel of human resources required to succeed given the likely entry modeLevel of dollar investment required given the likely entry modeLevel of impact if risk cannot be managed given the likely entry modeLevel of confidence in the size of the opportunity as described given the likely entry modeEstablish a composite rating for each market space (K, Appendix 1.2) of the attractive market criteria rating (see Topic 4) combined with the composite assessment of penetration success (see the Attractive Market Composite Assessment Engine in Appendix 1.7).In this way, identify the most attractive markets with the highest likelihood of meeting the success criteria threshold given the mode of entry (see the Attractive Market Composite Assessment Engine in Appendix 1.7). In the illustration in Appendix 1.7, Market F has the highest composite score for attractiveness and the highest likelihood of meeting the market penetration success threshold given the mode of entry.Rank order and prioritize the market spaces (K, Appendix 1.2) by the composite result, and identify the cumulative resource (financial or otherwise) requirement.By synthesizing the output from the prior steps, identify the selected initiatives (L, Appendix 1.2) to enter and develop the new or existing market space and/or close the market, capability, and competitive gaps such as: In-house start-up initiatives: new product development, hire new staff and technical resources (sales, marketing, research and development, etc.), license technology, training, and so forth.M&A initiative: acquire, merge, joint venture, alliance (L1, Appendix 1.2).Perform a strengths, weaknesses, opportunities, and threats (SWOT) analysis4 (J2, Appendix 1.2) for the company as a whole, as illustrated in Appendix 1.8. Identify your key company-level SWOTs and isolate active strategies or steps that will: Optimize each strength in your markets and close gaps.Correct or minimize the impact of your weaknesses and close gaps.Take advantage of each key opportunity available to you and close gaps.Minimize the impact of each imminent threat. And close gaps.

HOW—IF M&A IS VEHICLE TO CLOSE GAPS, IDENTIFY TARGETS

Where M&A is the likely or chosen entry mode, identify M&A target opportunities (L1, M, Appendix 1.2) to close the gaps in the most attractive and highly rated new or existing market spaces and engage in the M&A process (see Topic 2). Consider these approaches to identify acquisition targets:Develop a search mandate identifying the sought-after industry, market space, capabilities, technologies, products sought, and so on (see Topic 4).Provide the search mandate to finders, search firms, investment banks, and the like (see Topic 4).Interview large companies and universities that may be interested in dispositions of technologies or nonstrategic fit businesses in the market spaces identified.Conduct data mining to identify the producers of the critical value-added input in the market spaces identified. For example, search Thomas Register, Compustat, Standard & Poor’s, One Source, and Hoovers, among other sources.After target identification and preliminary fact finding and evaluation, measure the fit (M, Appendix 1.2) of each target's capabilities combined with the buyer's capabilities (as if the entities were combined) versus the requirements of each market, as illustrated in Appendix 1.9, to determine which acquisition candidates in which market provide the most improved gap closure, on a pro-forma post acquisition combined basis.

The following Appendices, as well as those presented earlier, are available for viewing or download on the Web site for this book at: www.wiley.com/go/emott. Please see the About the Web Site page at the back of this book for login information.

APPENDIX 1.3 Activity/Capability Analysis: Us versus the Market

APPENDIX 1.4 Activity/Capability Extension Analysis: Where Else Used Brainstorming Example

APPENDIX 1.5 Our Capabilities versus Market Requirements Assessment Engine

APPENDIX 1.6 Our Capabilities versus Competition Assessment Engine for Market A

APPENDIX 1.7 Attractive Market Composition Assignment Engine: Composite Assessment of Likely Penetration Success in Each Target Market

APPENDIX 1.8 SWOT Analysis Chart

APPENDIX 1.9 Competence Alignment Engine of Acquisition Targets in Markets F, A, J

1. This activity and capability extension analysis is grounded in the excellent work of John Stempeck, of Avalon Associates, Boston, MA, a strategy development consulting firm.

2. www.bain.com/management_tools/tools_competencies.asp?groupcode=2.

3. This activity and capability extension analysis is grounded in the excellent work of John Stempeck, of Avalon Associates, Boston, MA, a strategy development consulting firm.

4. SWOT analysis is credited to Albert Humphry of Stanford University, but its origin is not entirely clear. See www.marketingteacher.com/swot/history-of-swot.html for a survey of the origins of SWOT analysis.

Topic 2

M&A Process: Front to Back

This topic and Appendix 2.1 present an overview of the M&A process activity and stages typical of most corporate development processes. Auction M&A transactions, which share most of the activities presented but on a more compressed timeline, are covered in Topic 12.

APPENDIX 2.1 M&A Process Activity and Stages Map (Topic Reference)

The reader is encouraged to take the time to read through the sequential time line of activities on Appendix 2.1 to gain a feel of the flow of events. Topic numbers are listed in parentheses next to each activity that is expanded on in the text that follows.

DEFINITION OF THE M&A PROCESS

Preparation. Deal flow starts with strategy development and development of target acquisition criteria (see Topic 4) and runs through creation of deal flow.Acquisition criteria are developed in a collaborative process that attempts to capture the qualitative and quantitative attributes of attractive target markets and target companies. They are used as a screen to rule target candidates out or in.Deal flow can emanate from internal sources, including research and development, sales and marketing, corporate development efforts, and programs such as activity extension and brainstorming and external efforts, such as mandated investment banks, targeted searches, over-the-transom offerings, or competition.Activity and Contact. This activity starts with market and target evaluation including preliminary intelligence gathering, criteria screening, and a target prospect report.If not rejected at this stage, contact with the target and potential establishment of common, complementary interest between buyer and seller follows.Come to Terms. This stage encompasses expanded preliminary due diligence, deal valuation and offer structuring, deal financing and value creation, synergies realization, and integration plan development. A preliminary letter of intent (LOI), offer term sheet, and acquisition proposal are presented internally for go-forward approval and degrees of negotiation freedom.If not rejected at this stage, target contact, negotiation of deal elements, and a conditional offer ensue.Close It. This phase encompasses expanded final due diligence, final deal valuation and offer structuring, deal financing and a value creation, synergies realization, and integration plan. A final offer term sheet (LOI) and acquisition proposal are presented internally for go-forward approval and degrees of negotiation freedom.If not rejected at this stage, target contact, final LOI is agreed and negotiation of deal and principal contract terms ensues.Create Value. This stage includes the execution of integration plans and realization and measurement of deal synergy and market, product, and customer, objectives.Appendix 2.2 illustrates the typical level of involvement of various business functions pertinent to the each stage of the process on the Matrix of Responsibility and Authority in M&A Transaction Flow.

APPENDIX 2.2 Matrix of Responsibility and Authority in M&A Transaction Flow

Topic 3

Why M&A?

Topic 3 summarizes the rationale for undertaking M&A. Acquirers should have specific reasons that target their M&A effort to fill a strategic void (see Topic 1). M&A is not without risk. Having operational overlaps with potential targets is a reasoned way to mitigate potential risk impacts. Additionally, acquisition risk is mitigated by building your M&A capabilities with smaller, digestible deals before taking on a large one.

DEFINE THE ROLE AND GOAL FOR M&A

Based on your strategic planning process, know the role you want an acquisition to play (see Topics 1 and 2).What do you want out of M&A? Consider these choices: Improve market or channel access positionImprove product line or served market extensionFill a technology or other operational capability gapAchieve a targeted competitive advantagePromote growth or geographic expansionEliminate redundant costs (plants and overhead consolidation)Consolidate or exploit excess capacityImprove long-term return on investment (ROI)Do a roll-up or consolidation leading to an initial public offering (IPO) or strategic saleAchieve incremental size and volumeDo it just for the adventure (not a good idea)Deals are not about taking risk; they are about taking on and managing risk to achieve a desired end.The closer the capabilities and activities of the target company are to what the buyer knows and does well, the better the buyer can manage the risk of what can (and generally does) go wrong. (See Topics 26 and 27.)Having said that, many buyers enter into deals to fill certain buyer capability gaps with those possessed by the target.

LOOK FOR CAPABILITY OVERLAPS WITH TARGETS TO BALANCE ACQUISITION RISK

Strategic buyers should look for three or four overlaps between their own key characteristics and capabilities and those of the acquisition target to increase the likelihood of a successful acquisition and integration. Important overlaps can include: Served customer baseDistribution channel and selling processMarketing and product positioning processTechnology base employed and technology development processR&D project management processNew product development and deployment processLean manufacturing method and process expertiseProcurement process, vendor base, and vendor development processManagement processes and practicesCompany cultureDeals motivated to fill certain buyer capability gaps with those possessed by the target, which is often the case in strategic deals, are not unusual. In such deals, the buyer should have some overlap knowledge of the acquired capabilities. Elimination or enhancement of certain redundant capability overlaps and overhead expense is also often a motivator.The likelihood of post-closing deal success declines quickly where buyer knowledge of acquired capabilities is very limited, unless a highly effective integration planning process that executes well mitigates the lack of capability overlap.Things that can go wrong generally do; acquirers must remedy the problems quickly and a lack of acquired capability knowledge can be a problem if, for example, the acquired capabilities are found to be deficient or a key acquired employee leaves. (See Topics 51 and 52.) Buyers must be able to fix things that go wrong.The buyer must balance risk mitigation of overlaps with the need to expand the capability base.New entrants to M&A activity should start with smaller deals and build a set of acquisition and integration capabilities before tackling larger, more complex transactions.

Topic 4

Deal Criteria

Topic 4 discusses in depth the need for well-thought-out criteria to guide the acquisition search and candidate evaluation. Acquisition criteria capture the essence of what the acquirer is after and provide a basis for measuring both how close a target is to the ideal fit and helps identify the target's strengths and weaknesses. Criteria development allows the chief executive officer (CEO) and board of directors to emphasize what matters most to them. It must be emphasized during acquisition search and evaluation. This topic illustrates acquisition criteria and criteria rating.

DEAL CRITERIA DEVELOPMENT

Having clear acquisition criteria helps narrow your search, develop the search mandate, and eventually make choices between candidates. Illustration 4.1 provides an example of acquisition criteria.1 Readers should consider all and select those most relevant to their merger and acquisition goals.

ILLUSTRATION 4.1 POSSIBLE ACQUISITION CRITERIA

Strategy Output Criteria for Target Identification (see Topic 1)

Industry/business/product/service area sought to close identified gaps

Technology/know-how/enabling competency sought to close identified gaps

Geographic dispersion sought to close identified gaps

Qualitative Criteria for Target Consideration and Evaluation

Market Attractiveness Attributes of Target Served MarketValue ChainClearly defined chain of value-added steps from producer to customer to end consumerGrowth ForcesPositive; intrinsic mega-trend forces drive market growth at each stage of the value chainBarriers to EntryHigh technical know-how, client-critical function, and difficulty-level barriers exist for new competition; a performance legacy existsQuality ClientsSolid, stable, profitable client baseQuality EndPerformance-critical end of the served marketStabilityInherently resistant to other than major economic dislocationTechnical/IndustrialTechnology-driven producers or service providersDomesticPredominantly domestic-served market and customersSpecialty FranchiseProprietary niche positions predominate to serve market needsConcentrationCompetitive landscape broad; many competitors and offerings create ability to differentiate.Product/Business Attractiveness Attributes of Target Company That Can Create Significant Barriers to Entry if Not Easily Replicated by CompetitionCritical FunctionDelivery of solutions that provide a clear customer- determined critical function (technical impact, cost reduction, enabler) grounded in proprietary technology and know-how that drives the client purchasing decision for the target's product or serviceProblem SolvingHigh client problem solving is required through applications engineering directly with consumer/client/userBreedable TechnologyKnow-how must be growable and breedable into adjacent applications and client-critical function solutionsLow Relative CostProduct or service cost is small percentage of customer total product or service costInnovationProducts are subject to in-house and customer-driven technical improvementLow Obsolescence RiskReplacement technologies are not readily apparentLong Life CycleTarget products are at growth stage of long S curveDifficultyInherent product difficulty (handling, use, application) drives client need for solution relationships with targetExpertise RelationshipClient must have need to turn to differentiated expertiseRepeat BusinessConsumable, disposable process, product, or serviceLow Investment IntensityLow capital employed per dollar of salesHigh Switching CostCostly for customer to switch product once employedMultifunctionBase technology can be utilized in various applicationsTechnical ServiceHigh level of technical service, selling, and after-sales service requiredRegulatory DrivenProduct application environment may be driven by need to meet high regulatory thresholdsApplied R&D DrivenHigh degree of market requirement-driven applied research and development (R&D) is required (e.g., not new molecules; new innovative application of existing molecules).Proprietary PositionMeasurable, sustainable, differentiated in specialty market.Leadership PositionOne of top three competitors in served market or emerging leader in new marketEffective Marketing ProcessThoughtful, creative, focused, disciplined, customer focusedSound Management TeamPractical hands-on leadership, motivators, empowerment, lean enterprise execution and practice, innovative, strategic focusSound Management ProcessAccountable, effective metrics measurement, empowered employees, effective incentives, cross-dependence, no isolated silos, process thinkers and improversIntegration Synergy PotentialSignificant economic benefit possible from elimination or consolidation of duplicate activities and facilitiesCapability ComplementsNeeded capability complements existKey Characteristic OverlapsBuyer overlaps with key target characteristics and capabilities.Quantitative Fundamental Criteria for Target EvaluationSustainable Potential Gross Margin as a Percentage of SalesExceed 45% of salesSustainable Potential Earnings before Interest, Taxes Depreciation, and Amortization (EBITDA) as a Percentage of SalesExceed 25% of salesCapital-Intensity as a Percentage of SalesOperating capital to sales is less than 40% of salesServed Market SizeExceed $250 millionMarket Growth RateExceed 4 times real gross national product (GNP) plus inflationEBITDA Potential Growth RateExceeds market growth rate

Have a clearly stated description of the characteristics of the industry, technology, market segment, and product or service line sought, and include it in your criteria.Ensure that the criteria against which target candidates are measured also reflects the critical capability overlaps desired (see Topic 3).Acquisition candidates should compare favorably in their current state with most of the general, qualitative, and quantitative criteria or have the potential to get there under new owners.Develop criteria for a potential buyer that reflect the specific factors that result from its strategy development and strategic gap identification process (see Topic 1).Identify critical knock-out criteria that must be met by a potential target as it is or shortly after a change in ownership.Ensure that criteria developed for a given target also provide the framework to focus the due diligence process work (see Topic 10).Develop a quantitative rating for each potential candidate against the general and specific criteria to assist in completing the relative target attractiveness evaluation. Does the target meet the criteria or not? If not, where does it fall short? This observation can help you evaluate why and whether the target has the potential to meet the criteria post acquisition. A criteria rating approach is presented next.

CRITERIA RATING ENGINE

Appendix 4.1 presents an example of a criteria rating engine. Follow the numbered elements discussed next and in Appendix 4.1.Weight the criteria as to the relative importance of each to achieving strategic goals: what really matters to sustaining value growth in the judgment of the CEO and the board of directors (column 1). In Appendix 4.1 the weights range from 1 (least important) to 5 (most important).Minimum required rating (column 2) is based on the relative weight (column 1) times the desired overall minimum fit target (85% in column 8 of Appendix 4.1) as determined by the CEO and/or the board.Target criteria score (column 3) should be scored based on the ratings provided by the due diligence process team. Care must be taken to ensure an independent consensus rating based on factual observation and reasoned judgment, given that the desired weighted ratings are known.The minimum required weighted rating (column 4) is based on the relative weight (column 1) times the minimum required rating (column 2).The target weighted score (column 5) is based on the relative weight (column 1) times the target rating (column 3). The due diligence process must be focused on obtaining the knowledge required to make reasoned judgments of the target's attributes versus the criteria.The target score over (under) minimum rating (column 6) is the target's weighted score (column 5) less the minimum required weighted rating (column 4).The target weighted fit % (column 7) is an indication of how closely the target fits the established weighted criteria. Scores exceeding 100% indicate the target exceeds the criteria; scores less than 100% indicate the target does not meet the criteria. The weighted fit % equals column 5 divided by column 4 for all criteria groups other than the qualitative criteria. For the qualitative group criteria, the weighted fit % is the expected qualitative result (column 3), divided by the target result (column 2), times the CEO's importance factor for each item (column B).The deviation of the target fit % with the CEO's desired target fit % (85% in column 8 of Appendix 4.1) is shown in column 8 (column 7 less 85%).

APPENDIX 4.1 Criteria Rating Engine

The target composite weighted fit %—75.2% in the illustration (column 9)—is the sum of the weighted fits for each criteria group subtotal (general, market attractiveness, product and target attractiveness, qualitative) in column 9. The criteria group subtotals equals the sum of the target fit % for each criteria line item in the criteria group (column 7) times the subtotal percentage for each criteria group that each importance weight is to the total of all importance weights (column A).A secondary criteria rating evaluation should be made if the target composite weighted fit (column 9) falls below the desired fit (column 8) as it is predeal to evaluate whether the target fit is achievable in the hands of the buyer postdeal, after buyer improvements.The prospective postdeal evaluation will require estimating the impact of buyer initiatives within the target after the closing.The target composite weighted fit over (under) the minimum fit—9.8% in the illustration—is presented in total in column 10. It is the sum of the weighted over (under) fits for each criteria group subtotal (general, market attractiveness, product and target attractiveness, qualitative) in column 10. The subtotal weighted over (under) fits for each criteria group equals the sum of the target fit % for each criteria line item in the criteria group (column 8) times the subtotal percentage for each criteria group that each importance weight is to the total of all importance weights (column A).

CONCLUSION TO THE CRITERIA RATING ENGINE

The target composite weighted fit over (under) the minimum fit is a measure of how far the target's fit rating is—below the CEO's overall desired fit of 85% (9.8% below in the illustration) against all criteria and which criteria group is lacking most fit. On a weighted basis, the qualitative market attractiveness and quantitative measures exceed the CEO's expectations by 6%, but the general product and target attractiveness ratings are well below the CEO's weighted expectations by 15.8% for a net fit of –9.8% below.The takeaway may be that the team needs to reassess the attractiveness of the product and the business attributes of the target. While the target scores well on capital intensity, regulatory-driven barriers, and low-cost producer, it does not score well on technology, innovation, and related attributes, which might indicate lower barriers to entry and a weaker franchise position than the CEO hopes for.

WHERE DOES TARGET FALL ON COMPETITIVE CONTINUUM?

It is critical to have a meaningful understanding of the target and its served market in terms of the acquisition criteria. This understanding defines where the company falls on the competitive continuum and therefore how it competes (or should compete) and therefore what its strategic thrusts and initiatives are (or should be) in support of how it should compete.This understanding allows the buyer to test the consistency of the targets practices and the target's understanding of its position in its market place.