Mergers and acquisitions can be a potent leadership tool for CEOs – acquisitions can establish a presence quickly, they can accelerate change, they are a strategy for catching market leaders and there can be quick market-share gains where there was once inertia.
Acquisition is a key strategic growth alternative for business owners, but opportunities to acquire businesses can be difficult to come by in today’s competitive climate with buyers looking to deploy available capital and investors applying added pressure on CEOs to accelerate growth.
Yet, strategic M&A can rapidly reshape a business and help bring about organic growth with the right talent joining the organization.
What does it take to make a buy-side deal in Texas today?
At an Enlightened Speakers Series event in Dallas, three panelists looked at that question from different perspectives. They were: Daniel Vermeire, Managing Director of Corporate Finance Associates (CFA); John Martillo, the founder and CEO of SignaPay; and Jeff Kolke, Managing Director of Monroe Capital.
Vermeire said CFA tends to represent sellers in M&A deals, but lately is working from the buyers’ side. Sellers are still skittish after the Great Recession, he said, while buyers are aggressive, innovative and plentiful.
“The reason for that tends to be because there’s a lot of cash out there,” he said. “Private equity groups have about $1 trillion waiting to be put to work and invested in deals. Corporate America has something like $3 trillion of cash on their balance sheets – a big war chest waiting to go to work.”
To put that money to work, buyers are looking for proprietary deals. Those are deals that are not on the market, and the buyer is the only one in the game. The buyer can get in front of a company on its own terms and avoid having the purchase price run up in an auction, Vermeire said.
“It means getting in first and controlling the deal,” he added.
But in a proprietary deal, that means getting both parties on the same page. Vermeire said they both need to see the vision of the companies working together.
“That’s completely right,” Martillo said. “If you create that relationship early and have a bond created by the alignment of thoughts, then if both parties feel they are getting something out of this and the companies are aligned, the price looks fair.”
“You have to be fair,” said Vermeire. “You have to lay out a lot of information about how you arrived at a valuation and why you believe it’s a fair price in the market.” Often, keeping a sale proprietary cuts down on the time and risk involved. Over the past three years, Vermeire said there wasn’t a single proprietary deal he worked on where a company decided to look at other buyers.
Jeff Kolke said money is available to finance acquisition deals, and the structures of those deals have changed over the past six or seven years. Buyers have to consider a number of factors, ranging from pricing to financial structure, to flexibility of the deal, and speed and certainty of execution. “When you weigh each of these elements, it can dictate what type of structure you get and how much you’re going to pay for that structure,” he said.
Kolke said companies must weigh the price against the leverage, because too much leverage can be a bad thing. “Having the right capital structure with the right leverage point in order to operate your business without stressing the business over your fixed charge coverage is important,” he said. He listed four structures to finance acquisitions. (SEE DETAILS BELOW.)
The financial outcome is the obvious way to measure success, Vermeire said. Additional profits and margins are an important metric. Another is “moving the needle” – making sure the acquisition will have a significant impact on the company.
“More and more,’ he said, “we see people acquiring companies that are their size or larger through creative financing, through additional support of the management team, and, we’ve seen several transactions where we’re doubling the size of that company in less than a year and more than doubling their profitability.” That, he said, moves the needle. “That’s how we measure success.”
Martillo uses acquisitions to grow his payment processing business, SignaPay. But it would be too time consuming to add one merchant at a time. Instead, his growth efforts are now acquisitions of technology-based businesses. The success of software products like Square, the smartphone add-on that processes credit card transactions, has changed the landscape of the payments business, Martillo said.
“It’s technology that’s making a difference for me,” he said. “We have about 15,000 merchants now with some organic growth, but the acquisition of specific software is creating bigger and faster growth for us.”
In strategizing for growth, Martillo said he looks first at sectors where he does not have a presence. Then, he determines how to tie that business back to his. Vermeire uses a similar approach.
“I always look for strategic connections like acquisitions that fill in the gaps that the buyer may have,” he said.
Then, the caliber of the management team is critical. “We have to make sure we have the right people in the right places and they are people we can trust because we’d like to see our money come back to us as lenders,” Kolke said. We don’t want to have our investors put money into our funds and not have a trusted party.”
“Deals are all about the management,” said Martillo. “If you have an idea, it’s just an idea if you can’t execute.”
Vermeire said management is probably the number one factor a buyer must consider. “That company has to have strong enough management to take on an acquisition and take on another company,” he said. “These two companies may continue to exist separately or they may be merged as an entity, but the management teams are going to blend a little bit and there’s going to be a new culture.”
“With every transaction, we try to keep the best of what they have,” Martillo added. To that end, Kolke said his company does background checks in every deal on every executive in the C-suite before they complete the transaction and lend money.
So where are the acquisitions being made? Kolke said transactions are happening across a number of industries. He mentioned oil and gas, technology and health care. “Manufacturing is also growing, and we’re seeing a lot of folks moving their production from China back to Mexico or the U.S.,” he said.
Senior debt is money borrowed from a commercial bank or finance company by pledging a first lien of the company’s assets. Thus, in a bankruptcy scenario, this must be repaid first in the waterfall if the company goes out of business. Typically, senior debt only solutions are used in smaller acquisitions where lower leverage is required. Senior debt can typically provide funded leverage up to 3 – 3.25 times debt to EBITDA.
Traditional Senior/Junior Debt Structure
This type of debt structure has a traditional senior debt component (commercial bank loan), with a second lien or a mezzanine tranche. These add additional indebtedness of 1-1.50 times debt to EBITDA beyond the senior debt solution. Mezzanine financing is an unsecured tranche of debt. Second lien is a senior secured structure with, as the name indicates, a second lien behind the senior debt. These structures are more expensive, but provide extra leverage, reducing the amount of equity needed to fund transactions. They will require the use of intercreditor documents between the multiple lenders in addition to two separate credit documents.
Bifurcated Debt Structure
This is another dual debt structure. First, the structure utilizes an asset-based revolving credit loan via a commercial bank. (For companies that are current asset-heavy with a lot of inventory and A/R.) Revolving lines of credit secured with current assets will be the lowest cost of capital tranche available on a senior basis. Part two of a bifurcated structure adds a cash flow term loan B from a finance company, allowing the buyer to reduce the amount of equity necessary versus a senior only solution. This structure will also require an intercreditor and two separate credit documents.
Unitranche debt is a combination of junior and senior debt under one document with one lender at one blended price. With one party to negotiate with, the borrower’s legal costs are cut significantly and the speed and certainty of execution increases vs. a traditional senior / junior debt structure. Since there is only one lender, an intercreditor is not needed, saving three to five weeks in the closing process.
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