Are you and your company prepared for the M&A process?
Industry experts predict that the end of 2020 will be marked by an intense movement of M&A operations. But after all, what are these operations? What are the milestones involved from beginning to end of the process? Who are the players? What are the dynamics and precautions to be observed by companies conducting an M&A process, especially those that are looking for investors?
M&A is the acronym, in English, for Mergers & Acquisitions (Mergers & Acquisitions) and is the term generally used to describe the consolidation, in whole or in part, of companies, business units or assets.
Although an M&A transaction normally involves only 4 important milestones: valuation, due diligence, signing and closing, the process as a whole can easily take more than 18 months to complete.
But, before starting the long journey of the M&A process, the entrepreneur needs to do a deep reflection and answer the following questions: i) what is the purpose of the operation, ii) what type of investor does she want to prospect, iii) is he prepared to accept the changes that will need to be implemented?
Purpose of the M&A operation
The most common reasons cited by companies entering an M&A operation are:
Synergy / gain of scale – reduction of fixed costs through the elimination of structures that will be duplicated, for example: directorships, accounting, treasury, HR and other administrative areas;
Accelerate growth – the M&A operation is usually the alternative chosen when the company wants to acquire market share or accelerate the growth of its revenue without having to wait the time necessary for the implementation and maturation of a green field project that depends on obtaining licenses, construction and installation of equipment, training of employees, etc;
Cross-Selling – serving current customers with products or services complementary to existing ones;
Diversification / reduction of possible concentration – access new markets, customers, distribution channels or suppliers and, thus, reduce the risks arising from any possible concentration;
Vertical integration – the company sees benefits in moving forward / backward in the industry’s production chain, in order to capture value produced by the supplier or customer. There is a caveat here in the specific case of the company deciding to move forward in the chain by acquiring a customer – it must take into account the negative impact resulting from a possible boycott of current customers, who will also become competitors.
Access to technology / resources / governance / skilled labor (AKA acqui-hiring) – in the normal growth process, companies may decide to seek partners who provide resources, technology and / or specialized labor, as well as assist in the process of professionalization and development / strengthening of corporate governance structures and processes.
Here, a caveat applies to entrepreneurs who are looking for investors and whose purpose, in fact, is only to capitalize the company, improve its capital structure and, consequently, reduce financial expenses. Entering an M&A operation with a liquidity problem is the worst possible strategy – however good the potential investor’s intentions may be, he knows that time is in his favor and that, as the operation grows longer, more flexible ( or desperate) the entrepreneur will be able to negotiate the value and terms of the transaction.
Types of Investors for M&A operations
Regarding the type of investor, the entrepreneur must decide whether it makes more sense to seek a strategic or financial partner.
The strategic investor is usually a company that already operates in the same industry, or adjacent industry, and that seeks in the total or partial acquisition the benefits described above, such as: synergies, growth, diversification, etc. Thus, because of these benefits, the company will be willing to pay a higher amount for participation, as well as to contribute not only financial resources, but also technology, management, governance rules, compliance and access to global suppliers and distribution channels; in addition to actively participating in the discussion of strategic planning.
Finally, the strategic investor generally seeks to acquire control of the company or, at least, tries to negotiate the inclusion of this option in the investment contract, as it sees the acquisition of the company as part of its long-term planning. Therefore, no departure date.
In turn, the financial investor analyzes the M&A transaction as if it were a financial transaction – with an estimated rate of return due to the amount to be invested, the projected future cash flows and the pre-established exit date. In relation to additional capitalization support, the financial investor, in most cases, will also contribute to the company’s professionalization process, strengthen management and improve corporate governance structures and processes, always aiming to positively impact future cash flows company and thus increase the expected return on the transaction.
In other words, it can be said that the financial investor’s strategy is to acquire a stake (or the totality) of the company at the lowest possible value, scale the operation, make it more efficient and, after 5 to 7 years, exit the investment through the sale of the stake to another investor (usually strategic) or via IPO. And, it is because of this exit strategy via IPO that many entrepreneurs consider the entry of a financial investor (eg private equity firm) as being a step in preparing the company for going public.
Is the entrepreneur prepared to accept the changes that are necessary for the M&E process?
Even before defining the purpose of the operation and the type of investor that best suits the company’s strategy, it is crucial that the entrepreneur makes a deep reflection and is clear about the changes that will occur due to the entry of a new partner, in particular, in relation to its role in the company’s day-to-day activities.
This is a critical item, as it involves power and changes in the status quo, and this is where the transaction normally comes to a standstill or, once completed, the deterioration in the relationship between shareholders begins. Therefore, before starting the M&A process, it is extremely important that the entrepreneur understands the consequences (pains) of growth and the changes that will be necessary to implement in order to continue growing in a sustainable way.
Most entrepreneurs start their company with little capital, lean structure and processes completely dependent on their common sense. After all, no one goes around implementing an ERP and / or an organization chart with managers and directors to open a “small business in the neighborhood”. The company, at this stage, is practically just the entrepreneur, and it should be so. However, as the company grows and, for example, it needs to seek resources from third parties, some changes need to be made so that it can raise funds. “On a stand alone basis”, that is, based on its financial and economic performance , not guarantees.
To reach this stage, the company needs to implement new governance processes and rules – banks, for example, will require audited financial statements that, in turn, need to be generated in a robust and reliable ERP system in order for the audit to take place. give a “clean” opinion. This is not to say that the way the company has always been run was wrong. This only means that to move from “childhood” to “adolescence”, the company / entrepreneur will need to change its attitude and the way it relates to its creditors and other stakeholders. Providing disclosure is no longer an option and becomes an obligation.
These changes, however, are even more drastic when, in this process of growth, the entrepreneur starts to delegate the management of the company to an executive or decides to seek external partners. In these two situations, what the literature calls agency conflict can arise (Jensen & Meckling, 1976).
In short, the agency’s theory states that the decision-making agent, be it the controlling shareholder or executive, will not always make the best decision for the company and all shareholders.
In this sense, and in order to reduce these conflicts, aligning the interests of the agent with those of the owner, the company will have to assume costs, strengthening rules and structures of corporate governance, such as: implementation of the board of directors, audit, internal controls , code of conduct & ethics, etc. Which, unfortunately, most of the time, are seen as an increase in bureaucracy and loss of power by the entrepreneur.
After all, until then, the entrepreneur made the decisions alone and did not need to give satisfaction to his actions to anyone. Here again, the changes do not mean that everything that has been done so far was wrong. They, the changes, are only part (pains) of growth. The entrepreneur can always choose not to change, but it will hardly continue to grow and attract investors.
Anyway, this is the big dilemma that the entrepreneur must answer before starting a process.of M&A: “I want to keep the power and the status quo, leaving the company as it is, after all I am the owner; or think about the continuity of the company, looking for partners and adapting the governance processes and structures to attract them and allow the company’s sustainable growth ”?
Once the dilemma above has been answered honestly with itself, the entrepreneur will be able to move forward through the stages of the M&A process, which we will see below.
Author Jorge Zanette: Financial executive with over thirty years of experience that mix knowledge acquired in the strategic and financial management of national companies, with family control, and in the credit management of multinational financial institutions. He led, as CFO, the M&A process of two important companies in Rio Grande do Sul that resulted in the entry of an investment fund and a strategic investor.