m&a for executives

Jordan,Knauff & CompanyINVESTMENT BANKERS

Fall 2016

Before We Begin: Smartphones

Introduction: Bill Snow

Investment banker

SpeakerAuthor

Today’s Agenda Part I• What is investment banking?• Buying and selling companies • Misconceptions • Hiring an investment banker

Part II• The M&A process

Part III• Valuation

Part IV• The team• Documents• Negotiating

Part V• Managing expectations• Report card• Are you prepared?

Special bonus: A liberal sprinkling of anecdotes

Part IWhat is investment banking?MisconceptionsBuy and selling companies Hiring an investment banker

–Prepare–Control –Frame –Define

Understanding the M&A Process

What is Investment Banking?

Broker?Role reversal Shopping cart Thesis

M&A is not nebulous

A huge universe of business owners

Retaining i-bankers, you know, just in

BuyerBuye

Something

happens

Done deal!

Investment banker

Hanging around, waiting for a fee if

something happens

M&A is a Process

Business owner

Investment bankerHandles the process, the materials, business terms

Private equity firm

Corporate buyer

PE backed company

Typical consultants include:LawyerLegal termsAccountant/auditorInventory, Quality of Earnings, Bank Reconciliation

The Client The QB The Buyers

The buyer is the new owner, makes all decisions.

The investment banker is persona non grata

The Sudden Stop

Common Misconceptions

Easy Knowing buyers Industry experience Magic words Ask price Commodity work Realtor

Buying and Selling – Often Counterintuitive Typical misconceptions

Selling is difficult Buying is easy!

The Reality of Buying & Selling

Easy, Straightforward Selling a companyContacting buyersReally easyFinding a buyer “interested” in doing a deal

DifficultBuying a companyContacting sellers

DifficultBuying a company

Really, Really DifficultClosing a deal that makes sense for the seller

Buyers – What Not To Do! The perfect

target…for me

Harvard Seal

Let’s take a look an example - Exhibit 1

Anecdote – Pushing a Deal Packaging

company New Years Eve Pay off letter Sideways

Picking an M&A Investment Banker

What we think is important

Knowing a lot of buyers

Industry experience

“Magic words”

Determining the right “ask” price

Low cost provider

What is actually important

How the buyers list is created

Ability to “clear the market”

Techniques to enhance value

Handling the “ask” price question

Negotiating prowess

Anecdote – Are you experienced? Really?

LOST BROKER

An Investment Banker is not a Realtor

Fees• Monthly

retainer• Success fee Expenses

Warning! – Willingness to work without a monthly retainer

Techniques to Pick the Right Advisor Chemistry Negotiating

prowess The process Enhancing

valuation Check references

Checking References

Remember: Ask questions that give you usable data

Instead of asking“What did they charge?”

“How long did it take?”

“Do they know a lot of buyers?”

“Did they get the highest price?”

“Did they do a good job?”

You should ask“Based on the end result, was their work worth what you paid?”

You should ask“Based on the end result, was their work worth what you paid?”“Did they do what they said they’d do?”

You should ask“Based on the end result, was their work worth what you paid?”“Did they do what they said they’d do?”“Did they attend all meetings with buyers? If not, why?”

You should ask“Based on the end result, was their work worth what you paid?”“Did they do what they said they’d do?”“Did they attend all meetings with buyers? If not, why?”“Did the buyer try to re-trade the deal? How did your banker handle it?”

You should ask“Based on the end result, was their work worth what you paid?”“Did they do what they said they’d do?”“Did they attend all meetings with buyers? If not, why?”“Did the buyer try to re-trade the deal? How did your banker handle it?”“Could you have done this without them, on your own?”

Anecdote – Efficacy of QuestionsHow many miles to the nearest Blockbuster?

Lurking Problems Quality of Earnings Inventory The “ask price” question Owner succession Rent and accrued vacation Absent key team members Deal “re-trade” Working capital adjustment -

Exhibit 2

Anecdote – Working Capital• Packaging distributor• Just-in-Time (JIT)• Sales • Working capital

How to calculate average working capital?

Part II Coming Up!The M&A Process

Part II: The Step by Step M&A Process

Preparing For a Sale Owner…make thyself expendable Fix up the balance sheet

Cut dead weight Increase sales The add-back machine

Avoid Serial for Breakfast Parallel, not serial Advisors Chain of command

Process Overview 1. Create a Target List2. Make Contact 3. Send the Teaser4. Assure Confidentiality5. Send the Deal Book6. Obtain Indications of

Interest (IOI)

7. Meet With Buyers8. Obtain Letters of Intent

(LOI) 9. Undertake Due Diligence10.Draft a Purchase

Agreement 11.Close the Deal12.Handle Post-Closing

Events

Step 1: The Target List Sell Side• Suspects• Prospects • Collaborative Process• Approval

Buy Side•What does target get?• Criteria

Step 2: Contact! Buyers want to be contacted!

Sellers, meh Auction?AlchemyScreeners

Step 3: The Teaser Anonymous executive summary Just enough info to “tease” recipient

Be careful!

Step 4: Confidentiality

Sign a Confidentiality Agreement (CA)Buyer agrees to keep quietNo harm

Step 5: The “Book” Various namesSecurity Huge amount of info

Enough to make an offer

Staggered release

Step 6: Indication of Interest Dating phase – can see others

Valuation rangeNon-bindingExclusivity? No

Step 7: Management Meeting “Wizard of Oz”Seller provides update Facilities visitSandbox

Step 8: Letter of Intent (LOI) Getting engagedFirm offerExclusivity? YesBinding? NoPick the “best” one

Step 9: Due Diligence Kimono timeFull disclosure…mostly

Confirmatory only!

Step 9: Due Diligence, cont. Send in the cavalcade of consultantsSecure online data room

Step 10: Purchase Agreement Marriage licenseFinal documentBinding!FairnessSame time as due diligence

Red line ping-pong

Step 11: Closing Wedding dayFlow of fundsSign this……and sign thatMere formality

Step 12: Post Closing Stuff AnnouncementCollect final payments

IntegrationContinued involvement

Coming up, Part IIIValuation

Valuation is a complex mathematical formula…

…that largely depends upon what side I’m representing

What is Valuation?Confluence of cash flow and timeSome methods include–EBITDA basis–Contribution margin–Asset value–Multiple of gross profit–Multiple of revenue–Discounted cash flow

Valuation = Multiple X EBITDA

Business Owner POV

SimpleStraightforward…

…and not the full story!

Anecdote – Form of Consideration• Marketer of medical data • Accepted $33M deal• Lower offers were better, why?

Valuation = (Multiple X adjusted EBITDA)

+ cash – debt +/- working capital

adjustment

Investment Banker POV

Obviously better

+ cash – debt +/- working capital adjustment

+ enhancers - detractors

Valuation – Fuller Perspective

Revenue – bigger is betterGrowth – faster is betterProfits – $1M EBITDA, $3M

EBITDA, $5M EBITDA, $10M EBITDA

EBITDA margin – 10% usually very good, 15% outstanding

Minimal CAPEXStrong, capable management

team– “not going anywhere”

Customer relationships– Long term, no concentrations

Simple and understandable business model

Design skillsQuality accounting systems &

proceduresBuying/sourcing/pricing expertise © Jordan, Knauff & Company. Proprietary and Confidential. 50

Enhancers to Valuation Include:Inventory management– Just in TIME (JIT)– Presell orders

Fragmented industryLarge market ($1B+)Expansion opportunities– Geographic– Customers/markets– Products

Barriers to entryLimited cyclicalityLow regulatory riskUnique expertise– Intellectual Property (patents,

trade secrets)– Sales/marketing approach

Use of TechnologyFacilities/warehouse/

distribution center

Detractors to Valuation Include:A “motivated” sellerOwner viewed as integral to

successManagement– Lack of bench strength/managers

about to retire– Lack of succession plan

Market is declining/out of favorLack of profitsLow marginsDeclining revenuesCustomers– Concentration– Financial weakness

Large CAPEX needs

Poor labor/union relationsUnproductive employeesPoor systemsExcessive bad debtUnsellable inventoryLow barriers to entryOverly complex productLong sales cycleSeasonalitySmall marketMarket dominated by large

player(s)Bad reputation for qualityDirty, unorganized facility/offices

Valuation – Is That All There Is?

+ cash – debt+/- working capital adjustment)

+ enhancers - detractors

+ pro-forma benefit of combined entities

Pro-forma Valuation

Is paying 15X for a $5M EBITDA company reasonable?

Pro-forma Ice Bucket Challenge

Combined

100,000$ 50,000 50,000 40,000 10,000$

Kate & Zuzu's Bait Shop & Sushi Imporium

Pro-forma Example

If Kate acquired Zuzu, what multiple makes sense?

Kate's Bait Shop

Zuzu's Sushi Imporium

Rev 50,000$ 50,000$ COGS 25,000 25,000 GP 25,000 25,000 Expenses 20,000 20,000 EBITDA 5,000$ 5,000$

Pro-forma

105,000$ 48,000 57,000 37,000 20,000$

Anecdote – Nurses’ Scrubs Pro-forma

Seller• Sales decline• Marketing miscues• Losing money ($3M)

Buyer– PE backed – Profitable

Buyer paid $13M – why?

Valuation Presented In A Pitch

EBITDA Multiple Risk Profile Characteristics

1 High Risk Business out of control / Failure likely. Crisis Management is the norm.

2 Risky Small margins, depends very much on owner relationships, owner not staying on. Not growing - status quo.

3 Acceptable RiskMarket risk but acceptable. Below average margins. Other risks concerning marketability, owner staying, no growth, etc. Gives market share and sustainable future cash flows.

4 Low Risk Growing, average profits, good client base and some management. Not dependent solely on owner. Management stays.

5 Minimal Risk Growing, above average profits, diverse client base, management plan, processes, procedures, etc. Management stays.

6 Slam Dunk Risk Profile 4 and 5 plus management has shown propensity to grow firm, good solid profits, lots of growth potential, and management stays

Quantifying Valuation – Buyer’s POV

Anecdote – Facilities Enhanced Valuation

Seller had (maybe) ~$2M EBITDA Buyer paid $17.5M Why?

Anecdote – Systems Enhanced Valuation

Seller less than $1M EBITDA Big concentration Buyer paid nearly 5X Why?

Solving Valuation DifferencesEarn outSeller noteUsing stockLess than 100%

Net Proceeds Calculator

Exhibit 4

Part IV is next!

The Team, Documents Negotiating

The Team

Typical consultants include–Legal–Accounting/auditing–Wealth management–Investment banker

Anecdote – The Wrong Advisor• Lawyer with no M&A experience.

Benefits of an Intermediary

Investment Banker vs Business Broker Deal size Business type Staff and resources Sophistication Involvement

Sundry Team Members – depends on deal

– Marketing– IT/Database– Environmental

Chain of CommandPoor communication Establish Chain of Command

Pick up the phone!

M&A Documents

Indication of Interest IOI - Exhibit 5

Letter of Intent (LOI) - Exhibit 6

Purchase Agreement - Exhibit 7

Keys to Negotiating Success

Weak or strong hand Remember the goal Decision maker Rollercoaster ride ABC – Always Be Closing

Anecdote: How Strong is Your Hand?

Drink dispensing equipmentBuyer “re trade”Inventory$1.6M on due diligence

What was the result?

Negotiating Techniques

How do Buyers make a bid? Term sheet – Exhibit 8 What motivates/scares other

Anecdote – Find (the other side’s) Motivation Buyer• Made numerous offers

Seller• Son-in-law - doubled

business• Liked his independence

What got the deal done?

Negotiating Techniques (cont’d)

Successful tacticsCommon negotiating mistakes

Good faithSideways

Part V - Concluding

Managing expectations

Report cardAre you prepared?

Managing Expectations• Tax preparation• Wealth planning• Hockey stick• Trust the process

Where we are today

Where we know you can take

the business after you

buy it

Anecdote – Bird in Hand; No Tax Plan

• Light industrial staffing• The “yeah yeah yeahs”

Report Card for Your Business Are you prepared to

sell?• Revenue• Growth• EBITDA• Owner• Margin• Audits• CAPEX• Providing documents• Secret sauce

Are you prepared to buy?• Money• Targets• Thesis

Opportunity KnocksContacted by Buyer• Not unique• Meeting protocol• Proprietary – who benefits?

Contacted by Seller• Good and bad• Bake off

Last Anecdote – Your Reputation Buyer Unsuccessful acquisition attempts

Insular industry“Lookers but not serious.”

Thank you!If you have any questions, please feel free to contact me at your convenience:

William R. SnowManaging DirectorJordan, Knauff & Company200 W. Madison St. Suite 980Chicago, IL 60606312-254-5904wsnow@jordanknauff.comhttps://www.linkedin.com/in/billsnow

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