M&A: A Key Cylinder in the CFO’s Growth Engine - Part I
Growth is an often-discussed topic in the C-Suite and the Boardroom. Preferably profitable growth. A key avenue for step function growth is through mergers or acquisitions (M&A).
According to Reuters, M&A volume globally climbed 30% in Q1 2024 and nearly 60% in the USA.* The problem is, according the to Harvard Business Review, 70-90% of acquisitions fail.**
From developing the pool of M&A targets through successfully integrating the acquired company, CFOs should have their fingerprints all over an M&A transaction.
In his CFO Talk, The CEO/CFO Relationship, Tom W. Burke summarizes the critical role CFOs have played for him in successful mergers and acquisitions.
“The CFO needs to answer questions like, Is this truly accretive to the business? Can it be accretive to the business? What needs to change to bring more value? What does the integration plan look like? In order for, an acquisition to happen efficiently, the CFO has to be a big part of it.” - Tom Burke
Tom depends on a CFO who can summarize the deal financially, figure out what’s important, what it is going cost to make it work and how do we put the two businesses together.
If you are a CFO or finance leader partnering with your CEO to search for, analyze and execute on growth opportunities you’ll benefit from this 2 part series. Part I covers Target Identification to Shareholder Approval.
1. Strategic Planning and Target Identification:
Step 1. Defining objectives for M&A growth falls within the strategic planning process. It’s driven by growth goals and market knowledge that potential acquisition targets exist. Investment criteria, funding capabilities and the corporate risk profile should all be considered during the planning stage.
In the first of our 3 part series on planning we cover how to kick off your strategic planning process.
Preparing A Strategic Plan – Kicking Off Your Planning Process
Once the strategic parameters for an acquisition - growth objectives, investment size and criteria - are set, it’s time to identify potential target companies that align with these objectives. This involves market research, assessing industry trends, and evaluating potential synergies.
Searching for Merger Candidates
What companies will make a worthy partner for your business?
This article uses 3 questions and the two 2x2 matrixes to help whittle down ‘potential’ acquisition targets to ‘good’ acquisitions targets. Once the three questions are answered and grids prepared, you will have a wealth of knowledge with which to evaluate acquisition opportunities.
You will know who your top candidates are, the potential for sales growth, and efficiencies or synergies that can be realized. Armed with this information, the next step is to model the financial potential of an acquisition and determine the value to your business.
2. Preliminary Due Diligence:
After good targets have been identified conduct initial due diligence on the selected companies to assess their financial health, market position, operations, and potential risks. This helps to determine the viability of the merger and refine the list of targets.
M&A 101: The Role of Due Diligence in Mergers and Acquisitions
“The due diligence process is not only about checking financials and projections for the business, but also gaining a strong understanding of the business model; how the company conducts business, works with and services customers; vendor relationships; the talent of employees; and most importantly, how your business competes against other businesses in that industry.” - Brad Dearing
In this CFO Talk, Without Change, The M&A Boom Will Stunt Economic Growth, Grant Jones, MBA highlights 3 traps CFOs should avoid for making a successful acquisition.
“If you don’t have these three foundational value creation mindsets, you could have the best integration team in the world and it’s just not going to matter. Integration is simply a detailed project plan that outlines how you’re going to achieve your goal, why you did it, what you did and who you’re doing it with.” - Grant Jones
3. Valuation and Negotiation:
Step 3 includes performing a detailed financial analysis and valuation of the target company to determine its fair market value.
The following article summarizes what EBITDA is and why it matters. It also covers the EBITDA multiple, its value as a silver bullet and its shortcomings
Is EBITDA The Silver Bullet of Business Valuation? by Dave Bookbinder
“Although widely used, The Back of the Envelope Method and the Back of the Napkin Method are not accepted valuation techniques. Remember the expression: “He who acts as his own lawyer has a fool for a client?” Doing your own valuation is kind of like that - especially when the stakes are high.” - Dave Bookbinder
In his Guide to Financial Statement Analysis, Ehab summarizes techniques to analyze the income statement, balance sheet and cash flow statement. He also includes important metrics and ratios used in the analysis process.
A Guide to Financial Statement Analysis by Ehab Sobhy
“Among the primary tasks of an analyst is to do a substantial evaluation of financial statements. In A Guide to Financial Statement Analysis I will break down the most important types, as well as approaches, to financial analysis.” - Ehab Sobhy
In the piece below Dave Bookbinder uses the TV show Shark Tank to highlight different valuation methods while including key considerations for the sale of privately held businesses.
In The Shark Tank It’s All About Valuation by Dave Bookbinder
“ Why do the entrepreneurs and the Sharks on Shark Tank differ on valuation? The entrepreneurs are passionate about their business and believe their vision of the future will turn out exactly as presented. The Sharks, on the other hand, know from experience that a lot can go wrong and that most small businesses fail. Therefore, if the Sharks are going to write a big check to an entrepreneur, they will need to get a substantial rate of return on that investment to compensate them for taking the risk.” - Dave Bookbinder
Once a preliminary valuation is set the next step is to craft the key terms of the agreement, including what is being bought, purchase price, payment structure, and other deal terms.
In this report from John O’Dore he explains why Letters of Intent (LOI) have become standard in M&A.
Some Say LOI’s Aren’t Worth the Paper They’re Printed On. We Disagree by John O’Dore
Signing an LOI is a major milestone in any business sale transaction. It’s important to understand which elements of a well-constructed LOI are necessary and why, which are binding and non-binding, and which deal points should be negotiated in the LOI phase versus being deferred.
“LOI’s are worth more than the value of the paper they are printed on, and the color of that paper is green!” - John O’Dore
4. Definitive Agreement and Due Diligence:
Next, draft and finalize a definitive merger agreement that outlines the terms and conditions of the transaction. As these negotiations are occurring, conduct comprehensive due diligence to verify the accuracy of the target company’s financial and legal information.
Before this step is finished I recommend the CFO.University course, Introduction to Mergers and Acquisitions
In this course you get exposed to the basics of M&A. If you haven’t made a career out of investing in capital assets, you may benefit by taking the Investment Analysis I-III courses prior to this one.
Due diligence is a pain staking task. If done well, it should be. Curiosity may have killed the cat, but due diligence brought it back. Again. And Again. And Again. Focus due diligence on the areas most critical to deal success.
The following article by John O’Dore is written from the seller’s perspective.
Due Diligence Is Just Around The… Oh Wait, It’s Already Here. Be Prepared.
However, with some reverse engineering it’s easy to apply it to the buyer’s game plan. It includes a valuable list of due diligence items. John warns these will vary based on the industry and specific requests you may have. Still, most of these are common to any deal.
A few sensitive items – such as customer lists and some employee files – can usually wait until the deal is almost complete.
Apply the risk management principles in the article below to the target company.
Don’t be Vulnerable - Properly Assess the Risks in Your Business
Understanding how risk is managed in your acquisition target is instrumental in protecting your business from a catastrophic investment and will impact the risk premium of the transaction, improving or reducing the valuation. The process begins with a risk assessment of your target. Use the concepts in the article above, applied to you target to create a risk assessment. High risk or unknown risk categories create higher risk for the buyer, resulting in a lower offer price to the seller.
5. Regulatory Approval and Antitrust Review:
Step is to research and obtain the necessary regulatory approvals from government agencies and antitrust authorities, ensuring compliance with relevant laws and regulations governing mergers and acquisitions.
Even transactions that don’t seem ‘large’ on a relative scale can have qualities that qualify theme for antitrust review, so this antitrust primer from PitchBook is worth reviewing before entering a transaction.
M&A 101: What Antitrust Law Means For Mergers And Acquisitions
” The three main federal (USA) antitrust laws are the Sherman Antitrust Act, the Clayton Antitrust Act of 1914 and the Federal Trade Commission Act of 1914. The Sherman Act was enacted in 1890 and still remains the main statute that governs anticompetitive practices. The Clayton Act was subsequently enacted to bolster the antitrust regime by reaching potentially anti-competitive practices in their “incipiency,” perhaps most notably mergers and acquisitions. The Federal Trade Commission Act created by the Federal Trade Commission and prohibits “unfair methods of competition” and “unfair or deceptive acts or practices.” - Paul Jin
For other federal and state compliance rules don’t depend on your companies ‘experience’ unless you are and M&A firm. Having an experience M&A attorney on your team is one of the most valuable decisions you can make.
6. Shareholder Approval:
Seeking the necessary approval from shareholders of both the acquiring and target companies is nearly always required by corporate governance documents. If not managed effectively your shareholders can become a significant roadblock to a transaction. To prevent battles on both shareholder fronts, put your shareholders in the loop during step 1, the Strategic Planning and Target Identification phase. Board members get especially testy when blindsided with a significant request or event. Contemplating an M&A event qualifies as significant.
Having a plan to keep the Board updated without creating burdensome interference is an art whose main instruments are executive teamwork and practice. Preparing too much information can bog down or distract acquisition team members. Too little can alienate your Board Members. In the bright side, some of your Board members may have the experience to be excellent counsellors through the process. Tap into their expertise.
Your Corporate documents, articles of incorporation, by-laws, etc, will include any special protocols required for a transaction as substantial as an acquisition. Be familiar with them
Now would be a good time to reinvest in Governance. CFO.University can help you here with the Governance I: Introduction to Governance course.
Learn about steps 7-12 in the 2nd of our two part series here, M&A: A Key Cylinder in the CFO’s Growth Engine - Part II
7. Closing and Funding:
8. Integration Planning:
9. Day One Readiness:
10. Post-Merger Integration:
11. Stabilization and Optimization:
12. Continuous Monitoring and Adjustment:
*Global M&A picks up in Q1 after flurry of large deals - Reuters March 28, 2024
** Don’t Make This Common M&A Mistake - HBR March 2020
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