Sometimes you just want the ride to STOP so you can get off and slow down all the head spinning. When I was a kid, we couldn’t wait for the county fair to arrive every summer. There was the tractor pull, the pig scramble, and of course, the 4H showings. Like most county fairs, we also had side shows like throwing darts at balloons or dimes on dishes.
The center attraction was always something like “The Scrambler” or “The Octopus.” The rides most people just love to ride over and over again. But not me. No way. My head would spin round and round for what seemed like hours. I could not wait to get off, sit down, and stop the spinning.
You ever feel like that? You just want to get off the ride for a little while? Let it all slow down. Take a break from the employee issues, the investor calls, the board meetings, and the constant hustle for growth?
When the private equity and growth equity firms, along with the M&A advisors, are pounding out automated emails from their CRM’s it is tempting to take a few intro calls and start heading for the door. You read about the high SaaS multiples and get excited. But are you ready? Are you ready to build a pitch deck, a blind 1 or 2 page tickler with historical SaaS KPI’s, a 3 to 5 year financial forecast, sit through several management presentations, and survive due diligence without a reduction in enterprise value?
So buckle up, take some Dramamine, and let’s get started!
DISCLAIMER: This writing is in no way intended to be legal or financial advice. Please proceed with caution.
The first question you will deal with is whether or not to engage an M&A advisor. There are several considerations in the decision.
- Do you have the expertise to pull all the data together and present it in a coherent fashion?
- Do you have both the legal and financial depth to prepare for due diligence?
- Do you have the C-level and corporate development relationships in the strategic buyer sectors?
- Most of all, do you have the strategic thinking necessary to align the parties on value?
With great investors, and experienced transaction legal counsel, successful strategic deals can be consummated without the help of an M&A advisor. The real question you will be faced with will come later, after the transaction. When you ask yourself if you achieved the highest enterprise value possible by getting in front of the most strategic potentials. That is where an M&A advisor can add tremendous value.
If you choose to go with an M&A advisor, you will have to go through a selection and engagement process. To start with, it is a two-way street. They will need to be interested in you and your space too. There is a bit of due diligence in the selection process, long before you get in front of strategic buyers. Keep in mind, M&A advisors keep their eye on the market. They know when windows are opening and closing. They know the difference between consolidation amongst competitors to gain market share, and true strategic buyers that have gaps to fill in their product offerings.
The two main objectives are to narrow down the field to the firms that can get you the biggest deal with the highest probability of close.
Think of it as a 2×2 with highest enterprise value on one axis and probability of close on the other. You may want to go with high probability of close but sacrifice some level of enterprise value. Or on the other hand, you may be very willing to keep operating the business and only take a deal if it is at the highest possible enterprise value.
When looking for an M&A advisor, there are many factors to evaluate.
- Do they have SaaS experience? B2B? B2C?
- Do they have experience in your vertical? (health tech, legal tech, marketing tech, etc.)
- Are they a technology investment banker that does a little bit of SaaS?
- Are they a small boutique that focuses on your sector?
- What percent of their transactions are sell-side versus buy-side?
- Are they a large firm with lots of resources, but not so many you will get lost in the shuffle and end up with a less experienced team?
Sellers are fearful an advisor will try to give a sweetheart deal to the advisor's preferred buyer or push for a less than optimal deal just to get a success fee.
M&A Advisors are fearful a seller is simply conducting a market check (AKA kicking the tires) and has low to no intention of consummating a transaction.
Building a financial model
This is the monster. In every deal I’ve worked over the past 20+ years, the financial model had to be rebuilt. The problem usually starts with a weak chart of accounts that is not designed for a SaaS product. The revenues are frequently not properly split across SaaS plans making a cohort analysis time consuming and error prone. The cost of goods may not allocate certain customer facing roles, therefore throwing off any possible SaaS benchmarking of gross margin.
Okay, enough with the bad news. The financial model is also where you can shine like the sun on a Kansas summer day. When you get your SaaS metrics driving your business, it is a simple model to build, and more importantly, an effective model to use going forward. The financial model is critical to enterprise value. It is also critical to be realistic as it is common to see future year performance based earnouts tied to the model presented during the process.
Here are some of the key metrics to be included in the model.
- New logo count acquisition rate
- Average annual contract value
- Monthly recurring revenue or annual recurring revenue
- Customer acquisition cost
- Logo retention rate
- Gross dollar retention rate
- Net dollar retention rate
The Potential List [of buyers]
In parallel with building and tuning the financial model, both a long and short list of potential buyers is being developed. No contacts are made at this point as there needs to be a high level of confidence in the historical financials as well as the forecast. This list will contain both public and private companies. In today’s market, the list will most likely include private equity firms that are active in the space.
This part of the process is sometimes more art than science and requires a lot of collaboration with the sellers who know the market better than anyone. You are looking for potentials that are actively acquisitive, financially positioned and able, strategic not financial, and have a true business void they are filling and not just consolidating customer lists. There is a lot to it, but in the first pass it is better to be exhaustive.
The Tickler or Teaser [blind summary]
The rubber is hitting the road now. The financial model is built. The historical data has been tested and proven accurate. The forecast is solid. But what is the pitch? What is the compelling reason someone would be interested? Is it topline growth? Is it an innovative business model disruption? Is it intellectual property?
When reaching out to the potential list of buyers, the first conversation usually does not disclose the seller. It is best to have a relationship which has been nurtured over time. A relationship that allows for a quick question or two to test the appetite of the prospect. If they are public, is now a good time in relation to quarterly filings and announcements? If they are private, has their recent funding round opened the door for acquisitions? There are a lot of topics that can open the door.
If timing is good, they will usually be willing to at least look at a blind one or two page tickler or teaser document. The actual layout is always unique to the business. There will be a little about the company like years’ experience, maybe headcount, or number of customers. Definitely a simple clean view of financial highlights showing recent past few years of top and bottom lines. There will also be a few key metrics driving the business like trailing twelve month net dollar retention, or new logo growth year over year.
Make no mistake, this is a marketing document, and the messaging must be compelling. The layout and content are critical to catch and maintain the attention of the reader. Make the first impression count.
Executive Summary
You caught their attention, and the preliminary blind discussions and one pager set the stage for a more in-depth sharing of information. They are interested. Now what? The next step is to go to a non-disclosure agreement. With an NDA in place, the identity and more information can be shared. Each step is further testing the appetite and interest. The NDA is not just a normal NDA. For deal making, transactional attorneys have particular language they will want to include.
The next level of information usually comes in the form of an executive summary. It is rare to go to a full confidential information memorandum at this stage. The format of the executive summary varies a lot. Much like a pitch deck, each company has different value drivers they will want to frame. The executive summary expands on what was shared in the tickler document. If the tickler had a three line simple chart of historical financials, the executive summary might have a full page with a rolled up comparative income statement and narrative. The tickler might have stated the number of total headcount while the executive summary would include a high level org chart with the names and bios of key employees.
This is where things can start to get interesting. At each step along the way the potential list of acquirers is getting shorter and shorter. If your starting list was 50, it may have been cut down to 25 after the first round of calls. Then cut down to 15 who would sign NDA’s after the blind tickler. The executive summary might lose a few more, but it also might identify a party or two wanting to preempt the process.
Indications of Interest – Letters of Intent
Let’s not get ahead of ourselves. The IOI’s or LOI’s don’t just magically appear. Sure, on occasion everything snaps right into place like Legos on a Saturday morning with the kids. Honestly though, if a potential goes to IOI or LOI too soon in this phase, it should be a little worrisome. To date, the prospect has seen a tickler, had a few calls with an advisor, and reviewed the executive summary. There is still information they need to take a position on value. Most likely the executive summary will generate interest, but along with that interest will come questions. Some will be preliminary data requests; some will be a desire to speak with the company leadership. This is your “First Meeting.”
This first meeting is to get to know each other. It is important to know if the companies have compatible cultures and aligned objectives. Stick to the agenda and get the selling points across but don’t be too rigid. Know your numbers like the back of your hand. Look for clues on how familiar the potential acquirer is with your company and your space.
Defer any discussions of valuation back to your advisor. If pushed, simply say you have some thoughts on that, but ask them to speak to how they (the acquirer) value and structure deals? Pick up on any opportunities for synergies between the companies. Make mental notes of the questions the potential acquirer asks and use them to prepare for future meetings.
After a bit of a dance, and the application of serious negotiating skills, the indications of interest start to arrive. Most likely you set a date to have all indications in-house. For the most part, serious buyers adhere to timelines. There are always a few stragglers needing extra attention.
The list is narrowing to those truly aligned and interested. In our fictitious example mentioned above, we are down to around a dozen interested parties after the executive summary. Now with IOI’s and LOI’s coming in, the list will most likely be down in the single digits; not always, could be more, might be zero. Some numbers you will like, some you won’t. It is valuable to keep your emotions in control. A lot of sellers start to check out at this point if they don’t like what the market is telling them. Hang in there and sell the value and synergy of the relationship. It is a negotiation, maybe the most important one you have ever had.
The Data Room
The field is narrowed again to those “in the expected range” of value. Flurries of calls and emails are going back and forth trying to get to final numbers before a final date. The data room door is cracked open. Not yet open for full-on due diligence though.
All along the way, there has been work behind the scenes. The gathering of financial data, supporting documentations, employee census, employee agreements, customer lists, customer agreements, capitalization tables, intellectual property documentation, the list goes on and one.
The data room is a virtual location for all the records related to the upcoming due diligence process. Yes, if the process keeps moving forward, there is going to be due diligence with a selected partner.
Management Presentations
We are still not down to one yet. After the preliminary data room work and much negotiation, we have arrived at a very short list of prospective acquirers. All of these potentials will have been building their own models with projections, synergies, and redundancies. Time to compare notes.
Unlike the first meeting, this is way more than a “get to know you” meeting. There will hard questions about historical and projected financials. There will be a technical review of the software. The SaaS metrics will be covered in detail. If the teaser or tickler was like a 60 second elevator pitch, this management presentation is like the full blown 2 to 4 hour business dissection.
The presentation should flow much like any other investor pitch deck. The big difference is how easily the discussions can get derailed on a tangent. Each potential buyer will have different synergies and could want to dive deep on different topics. They can be exhausting. Depending on the number of potentials left in the list, this part of the process can pack your calendar for a couple of weeks.
Due Diligence
The management presentations are over. Some potentials may walk away at this point. Others might stick in the process. The final date for final numbers as arrived. Management has a hard decision to make. To go forward or not, and if so, with which potential acquirer. It is a tough call. I’ve seen sellers walk away irritated they wasted all their time. I’ve seen sellers push for more, just to have the buyers walk away. You must remember, you are in this process for a reason. You believe your company can have more opportunity with a combined entity than alone. When it is your baby, it is hard not to take things personally. But it is not personal. It is a negotiation.
You make the tough decision and select a single potential acquirer to go forward with into due diligence. You both agreed to the term sheet in the letter of intent. Most likely there is a “no shop” agreement for a certain amount of time to keep you from working with other potentials. There will be a target date set for closing. Of course, all of the deal terms too.
The data room door is now fully open. The buyer’s analysts, attorneys, and accountants are all digging in. Reviewing everything in detail. Everything. The common view by sellers is due diligence is designed to reduce enterprise value. While that does indeed happen on occasion, that is not the design.
We are getting close, but we are not done yet…
Definitive Agreement
Another parallel process which has been going on since the LOI was agreed to, is the drafting of a definitive agreement. This is where the lawyers make the big bucks. In theory this legal document replicates and completes the agreed terms in the LOI. However, the terms may have changed during due diligence and some terms were probably ambiguous in the LOI so the deal could move forward.
Without attempting to get into the details of the definitive agreement contents or negotiating process, it is important for a seller to take very seriously the representations, warranties, and disclosure statements. There are threads in these reps and warranties that go all the way back to the tickler document. The numbers shared at the beginning of the process in the tickler will be presented in more detail in the executive summary, then again in the management presentations and the confidential information memorandum, verified through due diligence, and finally documented in great detail in the reps, warranties and disclosure statements. Everything must connect and be extremely accurate.
The Closing
You signed! Whew, that was quite the ride. Before we get all excited about closing dinners and tombstones, we must remind ourselves of the reason we did the deal in the first place. We believe the business will be better after the merger than before, or we would not have closed. Mergers tend to fail when leadership teams “check-out” after closing. The real work starts now. Making the combined entity the best it can be.
We skipped a lot as we went through this process. There are negotiating techniques for brokers fees, retainers, and success fees. Then there is how to best present the company in all the ticklers, executive summaries, and management presentations. There can be very valuable coaching on how to have the “first meeting.” Oh, and when and how to allow the buyer to talk to your customers. This is a big one, especially if the potential acquirer is in any way competitive. No one wants to give up their customer list too early in a process.
Hope you found this M&A overview valuable and helped you in your decision making process. It can be an exciting ride!
DISCLAIMER: This writing is in no way intended to be legal or financial advice. Please proceed with caution.
Photo credit to Manki Kim
If you need help thinking through this or other leadership challenges, let’s have a discussion to see if I can help in some way.