Written by Mark Gaeto, Managing Partner
Ask any investment banker involved in M&A and they will tell you that “time kills deals.” For some strange reason, many sellers, buyers and others do not understand the soundness of this exceptionally wise advice.
All of us have heard the expression Carpe diem. We see it on tee shirts, coffee mugs and hear it frequently on TV or online, in books and various publications. Carpe diem, quam minimum credula postero is from Book 1 of the Roman poet Horace’s work Odes (23 BC). Translated it means, “Seize the day, put very little trust in tomorrow (the future)”. This advice is wonderfully apt for today’s M&A environment and is equally important in normal times.
One of the chief reasons or benefits for hiring a banker is that a banker improves a seller’s predictability of getting a deal done. The banker brings knowledge of a market, a proven sell-side structure, deal-making experience, a definitive plan for how to prepare for an exit, etc. All of this ensures improved deal success predictability and, of course, creates a “competitive dynamic” that drives up offers. However, things happen that can ruin any deal, and the more time it takes to complete a transaction, the more opportunity for unexpected and unwanted things to emerge, like a lost customer, a missed quarter, a key employee departure, health issues, or any variety of macro or world events such as a pandemic!
My own personal experience goes back to the dot.com crash. In the late nineties, my partners and I had a successful SAP implementation business, and we sold our firm a couple of months before that crash—March of 2000 – at a high valuation. We benefited from years of corporate reengineering initiatives and Year-2000 fears that drove ERP sales and created lofty valuations that existed pre-crash. We were lucky with timing. We were also well run and had very clean and granular financials, documented controls and methodologies, a solid team, and excellent ties to SAP. Our deal had no earnout element. Unfortunately, our peers (and some who were dear friends) who sold their SAP service business in the years post 2000 never exited as we did. The ERP craze decelerated, and newer technologies came to the forefront (Supply Chain, CRM, Business Warehousing, Procurement, E-commerce, etc.). For our peers, the buying fever for SAP ERP services firms cooled, growth slowed, company valuations slid lower and earnouts became more prevalent to better control buyer risk.
Fast forward a few years to the great recession where macro events disrupted a good time in M&A. Then to the EMR craze, and when I thought to myself, “didn’t I see this movie before?” The Patient Protection and Affordable Care Act was passed in March 2010. Within this law was a mandate requiring electronic medical records for all practitioners. Naturally, the EMR software and related services markets took off. However, most firms, and especially owners of EMR implementation firms, thought the new realized demand in services was the new normal. They were wrong. Hospitals are never an easy sell and, with the incentives of the new law expiring, the glow of that market dimmed. Just as the ERP market dimmed post Y2K. We saw sellers wait too long to exit and to take advantage of
this positive EMR growth cycle and, in doing so, they lost significant value! This type of market pattern occurs often.
Note to sellers: Technology “windows” (cycles) open and close, various trends ebb and flow, progress marches on, and today’s high-value firm can become tomorrow’s has-been.
Today, many deals could have been completed before yet another significant event that landed in the madness of the month of March—our current Covid19 pandemic. Prior to the pandemic, the market was at an all-time high in terms of valuations and deal activity. In this positive environment, buyers and sellers elongated negotiations. They took time to make decisions, hoping to squeeze every penny from one another and tweak every term. And, not taking the poet’s advice, many sellers and buyers trusted the future!
We witnessed one deal in which the buyer had an extremely complicated earnout model. It had dozens of integrated Excel tabs, and it required weeks of review and input. The buyer presented a lopsided (too buyer-friendly) purchase agreement and their attorneys had employee departures that slowed things down. This overengineering of structure, terms and unnecessary aggressiveness led to lengthy discussions. We had a deal nearly done prior to the shutdown. However, the deal died as the pandemic caused the buyer to revalue the deal to a point where it was unacceptable to the seller. Another transaction suffered drawn-out negotiations, taking days and even weeks to respond to the routine back and forth that happens in negotiations pre and post LOI. This stretched out deal discussions considerably. Just when a final deal was agreed to, the pandemic arrived. The future forecast was now unclear, the buyer reshaped the offer. Rightly so, the seller did not accept this new offer and walked away from the deal. Falcon got the parties back on track as the combination made perfect sense (and cents) for both sides. In the end, a win-win situation was agreed to. However, we had to accept a different deal structure and address an entirely new set of pandemic and other related issues that added more complexity and time (and legal costs) to a transaction situation that already had some unique features.
Time most certainly kills deals, allowing micro and macro events to derail the best of intentions.
We still believe it is a great time to prepare for and consider an exit, as stock prices are trading near historical highs, and interest rates are low. The adoption rate of digital transformation and other technologies is being greatly accelerated. Sellers, in certain segments, can take advantage of this pandemic environment and exit at pre-Covid values.
As we enter the post-Covid world, we expect the markets to remain volatile for the foreseeable future. Will a different president change the capital gains tax? As of this writing, Biden is advocating for a significant increase in the capital gains tax. How fast will we open-up the economy while protecting certain population segments? Will vaccines or therapeutics be available soon? We all need to think ahead and prepare for this new environment. Many sellers missed taking advantage of pre-Covid valuations by a couple of weeks, if not by days or hours. Hence, remember the age-old advice of the poet Horace, “Carpe diem, quam minimum credula postero” and try to use the following best practices when selling a business:
Before the deal:
• Improve your accounting methods, controls, systems, and reporting, and use accounting data as a strategic operational tool to measure the business more granularly. Think hard about having a sell-side quality-of-earnings report completed. These reports are worth every nickel (and the money spent is an add-back to cash flow/EBITDA).
• Set your company’s valuation range and establish a walk-away value. Your banker can do this.
• Perform a legal review and ensure you are up to date, organized, compliant and protected. Clean up and update your agreements—between partners, with management, vendors, customers, etc.
• Implement a budgeting process as well as a rigorous sales-pipeline management/revenue forecasting one. Think about a quality-of-pipeline analysis. (Check out www.qsstrategies.com.)
• Put a personal-wealth, tax and estate plan in place that anticipates an exit.
• If you can, improve, automate, and digitize the business as best you can.
• For other insights on deal preparation see link below (1).
During the deal:
• Use the negotiation process as an orderly information gathering exercise. Observe and adapt.
• Protect your critical deal points, deploy your negotiation capital wisely, and negotiate in sets of issues and not individual ones. Don’t become a “nuisance negotiator”
• Have a small, internal, deal team and establish the rules. Let your banker lead the process.
• Respond to data requests quickly and make decisions within 48 hours. If you properly prepared, this 48-hour window is achievable for most requests.
• Think hard but try not to overthink or overcomplicate things. Studies show that overthinking has overwhelmingly bad effects on decision making (2).
• Have weekly status calls internally with your team and banker and attorney, and one with the buyer team. Drive the process forward—to the most logical next step!
• Negotiations need to be live (ZOOM and MS Teams, for example) and preferably face to face. Use emails carefully and mainly for clarification or documentation purposes (3, 4, 5).
In closing, as everyone knows by now, carpe diem means “seize the day.” It is good advice overall but even more so in the realm of mergers and acquisitions. Seize the deal and, if you move efficiently and take the above recommendations, maximize your outcome!
Mark Gaeto is a managing director with Falcon Capital Partners, a leading mergers and acquisitions firm, where he directs their commercial technology practice.
Mark can be reached at 610-989-8903 or firstname.lastname@example.org.