M&A Readiness May Decide a Closed vs. Sideways Deal
Entrepreneurs of lower middle market companies are rarely prepared to engage with serious, sophisticated buyers when approached. It’s completely understandable, as founders are focused on what drives buyer interest which is growth and profitability. However, when buyers do show up, they expect clean and organized financials that can provide a macro and micro view of the business. This gap of financial reporting between founders and the “finance guys” is common and can be solved by hiring a CFO or M&A advisor to beef up and polish the financial and operational reporting. This may include outsourced accounting work as well, to ensure the financials are properly coded e.g. cost of goods (COGs), and are in accrual, which is incredibly important for subscription businesses (no investors want to see volatile month over month financials). So, while such options exist, what if you already have a highly interesting/interested unsolicited strategic buyer that is looking specifically for a business like yours? Should you ask them to wait three months? If so they may wait, may acquire another business (buyers are generally pursuing multiple targets at once) or change their strategy altogether.
Therefore, it’s prudent to begin your M&A readiness 6-24 months+ in advance of a desired transaction so when a strategic buyer or investor show up, you are ready to engage with your best foot forward, vs. providing half-baked, inaccurate information that will not allow an interested party to proceed with out some material level of clean-up and preparation that may cause discussions to go sideways. This also allows founders to be ready to engage at their option vs. the other way around, as well as gain valuable business insights that can support key decision making which is valuable independent of an M&A transaction.
A few examples come to mind where this gap existed and was highly problematic. Just recently, a founder mentioned a few reputable strategic buyers approached, and one was very synergistic and interested. The CEO was quite excited and had high expectations considering a few of his peers had received robust multiples. He asked me what the valuation and structure should be based on his trailing financial performance. After learning the basics to assess the valuation, I inquired about his 2023 projection. He mentioned he didn’t have a projection, nor have the resources to produce such a report. 🤦♂️ Further, he mentioned he expects a down year, yet struggled to articulate why and what the key drivers were. 🤦♂️🤦♂️I responded transparently that A) this is not going to support a valuation in line with your peers, B) you will need to have a projection prior to proceeding further with buyers, and C) we can help build out a forecast as part of our sell-side advisory engagement, although I’m not sure there’s a there there based on the value expectations coupled with the expected down year.
Another more dire instance was a former client we represented on the sell-side, that was under LOI with a buyer at a compelling valuation. Like the above, their financials were not in great shape, so during exclusivity we brought in an accounting firm that helped with the quality of earnings (QOE), and converting their books from cash to accrual. Luckily those bumps in the road got smoothed out. What couldn’t get smoothed out was that their year-to-date financials post QOE fell materially short of the pre-LOI projections. While the business was growing rapidly, there was too much optimism built into the plan, and the robust valuation became insupportable, ultimately causing the buyer to walk. Had the founders been more seasoned with their forecasting perhaps this outcome could have been diverted. Perhaps we could have applied more scrutiny to the projection as well (lesson learned when seeing hockey stick projections). Luckily this engagement had a happy ending as we ended up taking this client back out to market several months later with airtight materials and ended up closing a transaction at a slight discount to the initial offer. Many other instances like this come to mind ranging from founders struggling to describe their business in a clear and concise fashion, to producing overly complex financials which fail to let one see the forest through the trees.
We can work with companies to become M&A ready, at a comfortable pace that isn’t disruptive to founders who want to prioritize company growth and value creation. Post completion, this allows shareholders to quickly respond to interesting M&A inquiries, gain insight into how their business is valued by buyers, and experience a much smoother, more efficient due diligence process.
Beyond what has been mentioned above, see below for a typical M&A Readiness scope of work which can be done as an all encompassing engagement or more a la carte:
Company financial model that details trailing monthly, quarterly and annual financials along with comprehensive projection with key revenue and expense drivers
Revenue and margin by type, and by customers over the past 36 months
Key performance indicators such CAC, LTV, Churn, Net Revenue Retention, Engagement
Competitive landscape, comparable M&A transactions, and SWOT analysis
Company presentation describing all aspects of the business in clear and concise fashion utilizing items noted above
Data room
Oversight of 3rd party accounting firm for cash-to-accrual and clean-up
We have some availability for select M&A readiness engagements this month, so feel free to reach out and we can have an exploratory conversation.