Mergers and Acquisitions For Dummies (7 page)

Consideration

Consideration
is what Seller receives from Buyer as a result of selling the business. In its most obvious form, the consideration is cash, but cash is not the only way to pay for a business. Buyer may issue stock to Seller in exchange for the business. Seller may accept a note from Buyer (Buyer promises to pay later). Or perhaps the price of the business is contingent, and Buyer pays Seller an
earn-out
based on the performance of the business after the transaction's completion.

Consideration is not an either-or situation. In other words, the consideration may consist of some cash at closing, stock in the acquiring company, and an earn-out. Or perhaps the consideration is a note plus an earn-out. No single right or wrong way to structure a deal exists. Structuring a deal by using various forms of consideration is similar to twisting the knobs on a stereo: To get it just right, you may have to increase the bass and turn down the treble. Chapter 4 provides a much deeper dive into the ways Buyers can finance deals.

Consideration is usually a defined term and therefore capitalized in documents and so forth.

EBITDA

EBITDA (earnings before interest, tax, depreciation, and amortization) is one of those horrible business jargon terms, but it's unavoidable in M&A. EBITDA (and its variations) forms the basis for most deals.

EBITDA
is the cash flow of a company without accounting for interest payments or interest income, tax bills, and certain noncash expenses (depreciation and amortization). In other words, EBITDA measures the cash generated from doing what the company is supposed to do: sell its goods or services.

Why is this number so gosh-darn important? EBITDA is often (but not always) the basis a company uses to determine its valuation (see Chapter 12) and is often a defined term in the agreements and contracts. Banks quite often include EBITDA as one of the covenants for making a loan.

EBITDA is commonly pronounced
ee
-bah-dah. And in case you're wondering, EBITDA is not a generally accepted accounting principles (GAAP) term. (Neither is adjusted EBITDA, which I cover in the following section.) However, both EBITDA and adjusted EBITDA are perfectly acceptable terms for the purposes of M&A activities.

Adjusted EBITDA

Adjusted EBITDA,
which is EBITDA's wild and crazy cousin, is simply EBITDA with adjustments! For example, a business owner often takes a salary larger than industry standards, so a Buyer may want to add back part of that salary to arrive at a more reasonable level of earnings. Say the owner of a company with $20 million in revenue receives total compensation of $500,000 when the industry standard for the president of a like-sized company is $250,000. In this case, adding $250,000 (plus the pro-rated amount of income tax) back to the EBITDA figure makes sense.

Other adjustments to EBITDA may include add backs for other owner-related expenses (cars, gas, cellphone, country club, health club, and so on). If certain employees won't be part of the business after the deal is complete, adding back their salaries (and corresponding payroll tax and benefits expenses) is appropriate.

No set standard exists for adjusted EBITDA; adjusted EBITDA is whatever Buyer and Seller agree it is.

Although running certain personal expenses through a business may be common, the practice may run afoul of the IRS. Consult with your tax advisor for the proper treatment of personal expenses.

Closing

Closing
is what Buyer and Seller dream of! It's why we M&A folks do what we do. In fact, it's so important that I devote an entire chapter (Chapter 16) to closing. In a nutshell, closing is the day when Buyer hands over the consideration to Seller and Seller hands over the company to Buyer.

Adhering to Basic M&A Rules and Decorum

Knowing the M&A language is important (see the earlier section “Introducing Important Terms and Phrases”), but understanding the rules of the M&A game and the decorum for its participants is equally important. Much like a poker game, the actions, the inactions, the movements, the gestures — in other words, the “tells” — are hugely important in the world of buying and selling companies.

If you're going to get into the M&A business, you have to know what to do and what to expect. Those caught off guard are those who won't be successful. Simple as that. Inadvertently (and incorrectly) broadcasting yourself as an M&A amateur can be hazardous to the health of your deal.

Follow the steps to getting a deal done

Remember that the M&A process is a serial process — transactions follow a step-by-step process. The following list gives you an overview of that process; I strongly encourage you to check out Chapter 3, where I discuss the steps in more detail.

Even though M&A follows a step-by-step process, the process often isn't linear. It goes through unforeseen twists and turns, so you have to be able to adjust.

1. Compile a target list.

For Sellers, this means creating a list of potential Buyers, and for Buyers, this means a list of business owners who may be potential Sellers.

2. Make contact with the targets.

Reach out to an executive or owner of a company on your list from Step 1. I prefer to make phone calls when contacting Buyers and Sellers.

3. Send a “blind teaser” if you're selling or ask for an executive summary if you're buying.

If both sides (Buyer and Seller) have some level of interest in exploring a deal after the initial contact, Seller provides Buyer with a little bit of info in the form of an anonymous
teaser.
That way, Buyer isn't inundated with too much info, and Seller maintains confidentiality and anonymity.

4. Sign a confidentiality agreement.

In this legal document, Buyer promises not to disclose Seller's private information or even the fact that conversations about a potential transaction are ongoing.

5. Send an offering document if you're selling, or review the offering document if you're buying.

The
offering document
is the deal book, the document that contains the information about the company for sale. A well-written offering document should contain enough information for Buyer to make an offer.

6. Ask for an indication of interest if you're selling or submit one if you're buying.

Buyer submits a simple letter expressing his interest in doing a deal. If the indication meets Seller's approval, she invites Buyer to a meeting.

7. Conduct management meetings.

Management meetings give Buyer and Seller an opportunity to meet face to face. Seller provides Buyer with updated figures from when the offering document was written, and based on this update, Buyer may or may not submit a formal offer.

8. Ask for a letter of intent (LOI) if you're selling or submit one if you're buying.

The
LOI
is the formal offer. However, it's still nonbinding, so each party can still walk away from the deal at this stage.

9. Participate in due diligence.

Due diligence
occurs after Buyer and Seller come to terms. During this step, Buyer reviews, examines, and inspects Seller's books, records, contracts, and more to verify that all the Seller's claims are accurate.

10. Craft a purchase agreement.

During due diligence, Buyer and Seller write a purchase agreement to finalize the deal both sides negotiated. This document is final and legally binding.

11. Attend closing.

After due diligence is complete and the purchase agreement is drafted, Buyer and Seller close the deal. Seller turns over the keys of the business to Buyer; Buyer forks over money to Seller.

12. Deal with post-closing adjustments and integration.

A deal is not done the day it closes! In most cases, Buyer and Seller have some post-closing adjustments to navigate, and Buyer has the task of integrating the two companies.

Understand M&A etiquette

If you aren't careful, you can easily give off the wrong signal inadvertently during your M&A proceedings. Failure to follow up quickly, return calls, and give complete answers is an easy way to turn off the other side and kill a deal. Show interest in doing a deal. If you're not interested in pursuing a deal, communicate that to the other side. Here are a few more quick pointers to help you make the best impression:

Respond to a direct question with a direct answer.
Sellers most often break this rule. Instead of addressing a basic question like “What were revenues last year?” with a simple answer, Seller decides to dive into a 15-minute monologue about something that sounds impressive. In this case, Seller doesn't impress Buyer; Buyer merely gets bored and may even wonder what Seller is hiding.