Unlocking the Secrets to a Successful M&A Process: Outlier Valuations, Re-trades, and Other Key Considerations / Part 2 of 2
Navidar | November 15, 2021
In part two of this post, we reveal three more secrets for successfully positioning your company to receive an outlier valuation during the M&A process and also offer tips for avoiding reduced valuations or “re-trades.”
You can find part one of this post here.
Secret #4: The Biggest Mistake: A Mismatch Between Your Story and the Financials
Please make sure that you and your banker avoid the single biggest mistake that we see companies make in the M&A process. What is the mistake? Having a mismatch between your financial model—your quantitative story—and your qualitative positioning.
The real-world cases of these mismatches are highly varied, but one simple example will make the point. Suppose that a linchpin of your positioning is your superior solution, which is leagues ahead of the legacy solutions out there. You’re an up-and-coming company that can disrupt your sector. That’s a great qualitative story, but does it jive with your quantitative one, as expressed in your financial model?
If your model predicts the same rate of growth, rather than a faster growth rate, as your competitors or the rest of the market, you have a disconnect between your qualitative and quantitative stories. That disconnect will raise red flags among buyers and lead to some uncomfortable questions like: Is your product really that special? Is your company truly differentiated? Such disconnects can undermine your chances of receiving an outlier valuation in the sales process.
Other examples of critical quantitative-qualitative disconnects include presenting a financial model that:
– Uses assumptions that haven’t been thoroughly examined and tested.
– Shows an unjustified dramatic increase in sales in future years (the so-called “hockey stick projections”).
– Is not designed to withstand the extensive due diligence buyers will apply to your financial projections.
Any of these financial model shortcomings, as well as countless others, can easily destroy millions of dollars in deal value or derail your M&A transaction entirely.
Secret #5: Not All Buyers Are Created Equal
Different buyers will value your business in different ways and for different reasons. Moreover, different attributes of your company will appeal to different buyer groups.
As a result of this characteristic of the M&A market, Navidar works very closely with our clients to help them think about themselves as a collection of assets. We spend a great deal of time identifying how those different assets and attributes may be used to attract different groups of potential buyers.
The reality that companies are seen in different ways by different buyers is a critical characteristic of the M&A market and explains why we believe that customizing your positioning for different buyers is critical to a successful M&A outcome and achieving a premium valuation.
Secret #6: Preparation Is Essential and Advanced Preparation Is 90% of the Battle
Advanced preparation in the context of selling a company has many components (and even more subtleties), but a few of those components are worth examining.
First, as already discussed, your banker and you will need to work together to create your go-to-market story, which will undoubtedly be at least somewhat different from the story you are used to telling your customers and employees. Second, you must avoid any disconnects between your financial story and positioning as noted before.
Third, you must address and prepare thoughtful answers to any issues or weaknesses in your company before going to market. In other words, you’ll need to formulate answers to any known company problems before your banker approaches buyers who might be interested in acquiring your company. These issues include anything negative a buyer could discover in the due diligence process.
For example, Navidar had a client whose financial results varied significantly from quarter to quarter. Though the year-over-year pattern showed growth, there really was no discernable quarterly pattern in the company’s financials, and we realized that this might be a cause for concern among certain buyers.
So, we addressed this issue proactively before approaching any potential buyers and concluded that telling them that our client did not focus on quarterly revenues, but instead focused on year-over-year growth, would be the appropriate answer. Ultimately, our explanation for the lack of consistent quarterly patterns was a successful strategy because our client was acquired at an excellent valuation by a public company that absolutely focused on quarterly targets. Had we not addressed the quarterly pattern issue before going to market, it could have hurt the deal valuation or even scuttled it altogether.
Tips on Avoiding Re-Trades
Another major benefit of advanced preparation is that it helps to avoid the dreaded re-trade. A re-trade occurs when a prospective buyer, who has committed to a specific valuation and set of terms, attempts to reduce the valuation or add unfavorable terms later in the process, often in response to what the prospective buyer says are issues that came up during due diligence.
Although re-trades are unfortunately quite common in the M&A process, Navidar has been highly successful in avoiding them with our M&A clients. Our success rate is high because we encourage our clients to disclose potentially unfavorable information in a thoughtful way in the marketing materials we send to prospective buyers before they submit their bids and deal terms. Using this approach prevents a buyer from claiming that they discovered negative new information during due diligence.
Following are five top actions to take to avoid re-trades:
1. Complete an audit of your financial statements and ensure that they are properly presented in accordance with public company standards.
2. Complete a quality of earnings analysis.
3. Correctly compute key KPIs, such as customer acquisition cost, customer lifetime value, gross margin, and other key indicators of business health.
4. Properly prepare a financial projection model, built from the bottom up, driven by clear metrics and well-supported and defensible assumptions. Some sell-side bankers produce only top-down models, which are very difficult to defend and support.
5. Price in all information. Manage information flow to ensure there are no negative surprises during the exclusivity period.
We hope this two-part post provided insight into some of the key components—including appropriate positioning for buyers, rigorous financial modeling, and running a customized M&A process—that will put your company in the best position to succeed in the M&A game.
If you would like to discuss any of the advice provided above, or if you are currently seeking counsel on a potential M&A transaction, please contact Stephen Day at [email protected] or (512)765-6973.