Mergers and Acquisitions, A Primer

By Bart A. Basi and Marcus S. Renwick

Often when people think of mergers or acquisitions, thoughts of mega-mergers come to mind. The largest mergers in the history of the world happened within the past ten years. For most of us, these business transactions do not affect our life. However, for the small or mid-sized business owner, mergers and acquisitions (M&A) can be the key to a more successful, longer lasting business.

Merger and acquisition involves the M&A activity of businesses of any size. Middle-market merger and acquisition activity has been a big part of the merger and acquisition activity. This involves transactions between $10M and $100M. In fact in recent years, middle market activity has accounted for roughly 45 percent of M&A's. This activity is roughly ten times the amount of activity the mega-mergers have been experiencing. The remaining merger activity involves the small, closely held company. Many of these smaller transactions are not even publicized, yet they account for over 50 percent of all M&A activity in the United States.

Purposes for Mergers and Acquisitions
There are a variety of purposes for mergers and acquisitions, including the following…
Business Longevity — Human life is finite in years. Corporate life can be indefinite. Often entrepreneurs open and run businesses during their lives. Unfortunately upon their death or retirement, the business often ceases to exist. This is a negative occurrence, because not only does a source of family wealth disappear for the family of the owner, but the jobs associated with the business also disappear. This is why mergers and acquisitions are so important for all business owners today.

A number of business succession methods exist. A merger or acquisition can extend the life of a business beyond the life of the original owner. To do this, the business owner must find a business suitable to merge or acquire. Considerations such as type, price, location, age of the management and the like should be kept in mind when considering merging. Once the target company is found, the two businesses can be combined. Once combined, the new business will have the size and revenue necessary to carry on without the involvement of the original owner.

New Markets — New markets can also be broken into by means of a merger or acquisition. Entering a new market on your own may be hard or even impossible. With the use of a merger or acquisition, the business owner merely buys his or her way into a new market quickly and efficiently. Many businesses can operate well with another business in the same industry. This allows management to run both businesses with little or no training.¹

Supply Chain Costs — Along with entering new markets, supply chain costs can be reduced. Recently a television station paid a supplier for use of its movies. The supplier then raised the costs of the movies to beyond a profitable amount for the television company. The television company had to stop showing movies. This resulted in the supplier losing a lot of money and considering bankruptcy. Instead of going bankrupt, the television station bought the supplier. The supplier management was then fired. The new management then effectively reduced the cost of the movies to the station. Both companies became profitable. This is an extreme example of how supply-chain costs can be reduced, but it is a vivid example of the concept. If your business frequently uses a large quantity of materials from a common supplier, it may be more cost effective to buy your supplier than to deal with the problem.²

Increasing Capacity — In addition to cost savings, mergers and acquisitions can have the effect of correcting other weaknesses in the business. Often businesses suffer from poor capacity in their product line. Acquiring another business in the same product line can increase capacity. Furthermore, expertise belonging to the target company can become the property of the acquiring business.³

Miscellaneous — Mergers and acquisitions have existed for a long time. During the middle and late '90s, merger and acquisition activity was at record high. Over the past several years, M&A activity began to decline. The trend of increasing merger and acquisition activity is starting to pick up again. The trend is expected to continue for a variety of reasons that make the market ripe for M&A activity. The factors are as follows:

• Private equity funds have surplus capital to invest. These funds are willing to pay for profitable companies in the middle market.
• A lot of people have lost money in their investments. Typically people have bought stocks for $100 that are now worth $3. This is true in companies such as Priceline.com. The managers of these companies may feel compelled to get money back to their investors. If an entity walks in with the ability to buy everyone's stock for a larger price, insiders and officers may feel compelled to give their shareholders a better return and therefore allow the acquisition or merger.⁴
• Private business owners' acceptance of lower than expected valuations of their companies also contributes to this increased trend in M&A activity. As the Baby-Boomers are getting older and getting ready to retire, they are more accepting of lower valuations of their businesses. Even though once they were higher, you can't sell the past. Selling now for an aging business entrepreneur is usually a good way to retire, even if the dollar value of the business is not what it once was.
• Many companies are doing well. However a lot of companies are doing poorly. Distressed companies are often a good bargain and someone can solve their problems quite easily with money and know-how.⁵

Types of Buyers
First of all, both buyers and sellers must understand that there are different types of buyers in the market. Each buyer has different intentions. The types of buyers are strategic, financial and consolidators.

Strategic buyers look for companies possessing the following characteristics:

• Similar product lines,
• Products that can be sold through the same channels as their own product,
• New locations,
• Technology to give them competitive advantage,
• Systems that can reduce buyer's cost,
• Ability to integrate.⁶

Financial buyers are buyers who buy businesses for the internal rate of return. The price they pay is a function of the expected cash flow generation. These buyers tend to spend more for businesses during times they can borrow money at a lower interest rate. Management is usually allowed to stay for a period of three to five years. These types of investors are able to recruit highly skilled management to strengthen the team when it is needed. There are many financial buyers in today's market.

Consolidators tend to buy companies at premiums with the intent of grouping them together and then building liquidity to issue an initial public offering.

Preparing to Sell
Recent technological developments have made selling a business easier. Sellers can now advertise their business on the Internet with the assistance of an agent and/or business broker.

Selling a business requires good timing. As Baby-Boomers are getting set to retire and pass on their business, they must take market forces into account. This requires potentially many hours of planning ahead of time. If this is not done, the retiree may either have to delay retirement or accept a lower price then what is wanted for the business. Therefore, it is beneficial for the seller to know what kind of deal is good for the business in advance.

The first step in selling a business is to obtain a detailed valuation of the business. This will allow you to see what your business is worth and if you actually want to sell it for the price it is valued at or hold onto the business until a future time.

Next, the company must be marketed to potential buyers. A list of potential buyers should be drawn up, contacted and screened before offers can be accepted. Be patient in this step of the process. Not all buyers are ready to buy a company for the price asked. This step can potentially take several months.

Once the potential buyers have decided to buy, offers will be made. The seller then must decide on which buyer's offer to accept in the deal. The agent of the seller should guide the seller through all steps of the sale including negotiations, due diligence and consummation of the deal.

In conclusion, it is critical that the seller have competent advisors and counsel throughout the selling of a business. A valuation that is too low can easily eliminate millions of dollars the seller is entitled to in a transaction. If the business is marketed and sold to the wrong buyer, the seller could again potentially lose millions of dollars. Therefore it is imperative for the seller to have competent agents throughout the process of selling a business.

Preparing to Buy
Buying is different from selling a business. Instead of the valuation of the seller being important, knowing the value that you can afford to pay becomes important. It is important for buyers to know that today, 40-50 percent of the M&A costs can be financed.

It is important to have an acquisition strategy. The purposes described in this article should serve as a good outline of possibilities to look for when planning a merger or acquisition. Having a strategy ahead of time will allow you to jump into a business transaction when the opportunity arrives and not six months later. Think of the time you saw an item on sale, but did not realize you would gain by buying at that time. Then you waited and the item went off sale. The next time you went into the store you realized you should have bought it when it was on sale. Has this ever happened to you? Planning will prevent this from happening to the buyer.

Be proactive. When planning for an M&A, the buyer should know how much he or she can spend. Having this settled beforehand and having bank-financing set up can allow you to seize an opportunity when it arises as opposed to watching the opportunity run away from you.

Focus on the future. Have an integration plan for your business to integrate with the new business. Plans made ahead of time can prevent confusion in the future.⁷

Most of all, when hoping to buy a business or perform other M&A activity, remember to be patient. Most M&A activity does not happen from start to finish in one day. Sometimes the deals take years to hammer out. The important thing in these transactions is to be as proactive as possible when planning and then be patient when doing it.⁸

Conclusion
M&A activity is increasing and is expected to increase in the coming years. Your business can benefit from this hot market. Knowing what to look for and planning can lead to a successful and beneficial merger or acquisition for both parties. A successful merger or acquisition can improve your business through a number of ways, including geography, production or market. As the population ages and the market picks up, business owners should be aware of and investigate opportunities which can be beneficial.⁹

Bart Basi is a CPA and attorney at The Center for Financial, Legal & Tax Planning, Inc., based in Marion, Illinois. Marcus S. Renwick is the director of publications with the firm.
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¹ Paul Smith, “Six Keys To Successful Acquisitions,” Modern Distribution Management, March 25, 2003.
² Smith.
³ Smith.
⁴ Smith.
⁵ Smith.
⁶ “Historical Transactions: Types of Buyers' Deal Structure,” Valuations, September 2002. Cherry Tree.
⁷ Smith.
⁸ Smith.
⁹ Smith.

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The MHEDA Journal • Third Quarter 2003 • Volume 32, No. 3 • Contents are Copyright © Data Key Communications, Inc.
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