The M&A Lifecycle: Evaluation Phase

The evaluation phase of the M&A lifecycle takes the buyer from target selection all the way through to a closed deal.

This article is the second in three articles on the M&A lifecycle series. In the first article, we covered what we call the Planning Phase. The goal of the planning phase is to create a detailed strategy that will help predict various outcomes and reduce the number of possible surprises. The next step is initiating the strategy and evaluating and negotiating with potential targets.

The Evaluation Phase Overview

The evaluation phase will begin with your first outreach to your target and end with a signed sale and purchase agreement. The primary objectives in this phase are to identify the ideal target and initiate a favorable deal. Mistakes like overcommitting to the wrong target or overpaying for the acquisition can destine a deal for failure, even if everything else goes perfectly through integration.

Contacting the Target

The moment you contact your target, future legal concerns arise should there ever be any litigation. You must have engaged an advisor at this time to minimize the risk and maximize the deal's value. Your advisor can reach out to the target on a no-name basis on your behalf, which you cannot do without misrepresenting yourself. Advisor outreach also allows you to collect unbiased information from the company regarding their interest in a possible deal. Throughout the deal, your advisor will act as a buffer between you and the seller, maintaining a positive relationship between all parties.

The goal at this stage in the conversation is to identify if there is any interest in selling and what the seller's motivation might be. With little motivation to sell, the buyer may be forced to offer a purchase price well above a reasonable valuation. Buyer and seller should share preliminary expectations to ensure little time is wasted should either party be disinterested.

Valuation

Once the seller and buyer are interested in a potential deal, the next step is to sign a confidentiality agreement and the seller will disclose detailed information about their company to the buyer. If the seller is well-prepared, they will share a Confidential Information Memorandum (CIM) with the buyer. The CIM is not a required document, but most medium to large deals will include one. Typically the CIM sometimes called a Confidential Business Memorandum (CBM), is prepared by an M&A advisor of the seller. The CIM is also a marketing piece designed to make the seller look as enticing as possible. The CIM will include the seller's pertinent information, including financials, HR info, market overview, product analysis, and more.  

To avoid overpaying, the buyer must value the target on a stand-alone basis. Use multiple valuation techniques and evaluate the target as if there were no synergies to your current operations. You do not want to increase the purchase price based on your expectations of synergy with the target. Of course, those synergies should be separately evaluated and understood, but you don't pay for them.

Ownership will also play a significant role in determining the purchase price. Small, private companies with less sophisticated owners may be willing to accept a lower price. Private equity and venture capital ownership will be tough negotiators looking to maximize their exit value. They are very sophisticated, highly experienced sellers.

Negotiations and Letter of Intent (LOI)

Before approaching the negotiating table, consider the items most important to your side of the deal and the seller's side. When you start negotiations, establish the points that are important to the seller first, this will give you an easier time getting your points accepted later.

A Letter of Intent (LOI), called a Heads of Terms if you're in the UK, is a non-binding agreement about the terms of the deal. However, it is common to have a few binding items in the LOI, such as a "no-shop clause," which prevents the seller from entering into sale discussions with another buyer for a limited period, giving exclusive rights to you as the buyer. Savvy buyers will be wary of any seller who would not agree to this clause due to the amount of time and resources required for the deal process.

The LOI will outline the price and terms and describe the assets, liabilities, diligence timeline, and more. The LOI will be the starting point for the eventual Sale & Purchase Agreement (SPA), which is the ultimate, binding sale document. The LOI will be high-level relative to the SPA, but it is essential to agree on terms now to avoid a headache later. Deals with significant changes to terms between the LOI and SPA often end up with difficult negotiations later and frustrated parties on both sides of the deal.

Due Diligence

The infamous Due Diligence stage of the deal is where your company will spend four weeks or longer comprehensively examining the seller's company. This process will begin with a large data dump from the seller that your company will have access to parse through. In an ideal world, the seller is well-organized and documented, but that will not always be the case.

This stage is almost always carried out by specialist advisers familiar with the diligence process. Most items are analyzed historically 3-5 years prior. Some diligence items include but are not limited to:

  • Organizational and management structure
  • Facilities information: openings, closings, turnarounds, maintenance, etc.
  • Consolidated financials, trial balances, reconciliations, etc.
  • Internal and external audit work papers and other details
  • Contracts
  • Employee agreements, benefits plans, compensation structure, etc.
  • Taxes
  • Environmental matters
  • Regulatory & Legal matters
  • Litigation
  • Intellectual Property
  • Real & Personal Property
  • Industry and research & development overview

You want the seller to disclose any proverbial skeletons in the closet. The SPA will include warranties that contractually obligate the seller to disclose most items requiring attention, but you want to be aware of these as early as possible.

Sale & Purchase Agreement (SPA)

By now, you have likely surmised that the SPA is the end-all-be-all document of the deal. The SPA is the binding legal document that governs the relationship between buyer and seller. To those unfamiliar with the M&A process, a SPA can be an overwhelming document to view. A typical SPA can be upwards of 100 pages for high-value transactions. The LOI is the starting point for the SPA and is developed in tandem with the diligence process. These are documents exclusively prepared by legal professionals.

As mentioned above, disclosure from the seller is critical. You want the seller to put anything and everything on the table that may be relevant information to you as the buyer. More info best allows you to evaluate the deal's value, craft representations, warranties, etc.

The warranties section of the SPA is typically the longest, and for a good reason. The warranties section is where you, as the buyer, can seek indemnity if certain representations about the seller prove false. There are standard warranties, but you will also have drafted warranties related to your findings in diligence and seller disclosures. Ambiguous warranties are best avoided, though you can never entirely pacify litigation risk here.

Next we will cover the final phase on the M&A Lifecycle, the Execution Phase.


If you would like to speak with an experienced advisor who can help walk you through your M&A thoughts and challenges, please feel free to
contact our firm.

Want regular insights on finance and leadership?

Subscribe and we will send you the latest articles and resources to help you better run your finance function.