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Selling a Business? Roles Played by M&A Participants
Mergers and acquisitions (M&A) can appear extremely complex with numerous participants involved in various transaction structures and processes. Adding to the confusion, industry players are often coined multiple, synonymous names. Many outside Wall Street have viewed the M&A industry as a byzantine empire of financial wizardry.
Aside from the various current transaction types and associated financial engineering, this article provides a structured outline of the roles played by various M&A participants. In any given transaction, M&A participants can be classified as sellers, buyers, consultants or financiers. The role of each is outlined below.
The number of shareholders in a particular company can vary from one person to thousands, but for the purposes of this article, the number of shareholders is not significant. Collectively, the stakeholders are referred to as vendors.
In general, the buyer universe is divided into three camps: financial buyers, strategic buyers and public investors. Financial buyers are companies whose business model is to buy, develop and then sell the business. Financial buyers acquire operating companies for their fund’s portfolio by making direct equity investments in these companies in exchange for a percentage ownership. By doing so, financial buyers expect to profit from both the cash flow generated by the operating company and the capital gains realized upon exit (sale of the company). So financial buyers acquire and grow businesses in anticipation of executing a future exit strategy. An exit provides the financial buyer with liquidity (converting their equity into cash) to either reinvest in the new company or to allocate to the firm’s limited partners (an entity that contributes capital to the financial buyer’s fund).
Financial buyers’ investment preferences typically fall within specific investment bandwidths that match corporate growth stages—from startup to maturity. As a result, different financial buyers are more prominent at different stages of a company’s life cycle. As a result, financial buyers are often classified by the maturity and size of the companies in which they prefer to invest. Although there is some overlap within each of the categories, the following three distinct types of financial buyers are recognized industry nomenclature:
* Angel investors: Angel investors are generally high net worth individuals who support an entrepreneur in the startup phase of a company. Angel investors hope to back a good entrepreneur with a good idea. Along with venture capital firms, angel investors provide an initial round of investment to a newly formed company.
* Venture capital firms: Venture capital firms (VCs) typically invest in companies from a pool of money (a fund). Like angel investors, venture capital firms invest in the early stages of a company’s life cycle. However, because VCs have sufficient funds to invest more than a high net worth individual, as a group, venture capital firms often invest in growth companies compared to angel investors.
* Private Equity Firms: Private equity firms (sometimes called financial sponsors, buyout firms, or investment firms) almost always operate with invested money contributed from a variety of sources, including wealthy individuals, pension funds, trusts, endowments, and funds-of-funds. While funds are always the exception, private equity investors typically invest in companies that have matured beyond proof of concept, where the company has a defined market position, a solid revenue base, sustainable cash flow, and some competitive advantage, yet still maintains it. Plenty of opportunities for further growth and expansion.
It should be noted that while most private equity firms operate from committed capital while closing deals in the market, there are also unfunded sponsors, who essentially act as opportunity seekers. Once they find a business they want to buy, they try to raise the necessary capital. Relative to a private equity buyer with committed capital funding, an unfunded sponsor is at a disadvantage because, due to the lack of committed capital, the seller may perceive him or her as a more risky candidate to close the deal. Conversely, an unfunded sponsor has less pressure to make acquisitions because he or she does not have an idle pool of capital waiting for an investment opportunity.
Strategic buyers (also called industry buyers or corporate acquirers) are companies that are geared to operate primarily in a given market or industry. Strategic buyers typically acquire companies for the synergies created by combining two businesses. Synergies can include revenue growth opportunities, cost reductions, balance sheet improvements, or simply market size. Therefore, strategic buyers consider acquisitions with an integration strategy in mind rather than an exit strategy (as in the case of an economic buyer).
Because of the opportunity to leverage potential synergies, it is generally believed that strategic buyers should be able to justify a higher price for a target company compared to a financial buyer for the same company. However, in certain instances, financial buyers can look and act like strategic/industry buyers if they hold complementary operating companies in their portfolio. That is why finding business profiles of portfolio companies owned by private equity firms is important to find a target financial buyer who can act like a strategic buyer.
Unlike financial buyers and strategic buyers, the seller may instead choose to sell the company to public investors by floating some or all of the company’s shares on the securities market through an initial public offering (IPO). If the selling company is already publicly traded, it may also choose to issue new, additional shares to the investing public through a secondary offering (also called a follow-on offering). Publicly traded companies are usually more mature and established, with enough historical performance to better measure the company’s performance. While a public offering can offer an attractive valuation for the seller, the process is also very expensive and comes with the burden of strict regulatory constraints for the company going forward.
Advisors to M&A transactions usually consist of M&A consultants and professional service providers. Similar to what real estate agents do, M&A advisors are the link between the buyer and the seller and are usually the catalyst that moves the transaction forward. M&A advisors go by a variety of names, differentiated by the size of the transaction they typically handle. As general guidelines for the purposes of our M&A Advisory Firm Data Module, although there are no generally accepted thresholds in the industry to clearly define where one type of firm ends and another begins:
* Investment bankers serve clients whose enterprise value consistently exceeds $50 million (on the low end and often in the billions).
* Middle market investment bankers (also called intermediaries) typically work on deals with enterprise values between $5 million and $75 million.
* Business brokers are firms that consistently work on transactions with an enterprise value of less than $5 million.
Other professional services typically involved in M&A transactions include transaction attorneys, accountants, and valuation service providers. The involvement of transactional lawyers in transactions varies by firm and transaction. However, at a minimum, transactional attorneys have primary responsibility for drafting the contract and may also participate in negotiations. Accountants provide financial and tax advice to the principals (buyer and seller) in a transaction. Frequently in M&A deals, an independent valuation of the company is required or required. This is done by a valuation service provider, whose goal is to assign a third-party, fair market value to the company. Private Equity Information also provides clients with data modules of valuation service providers.
Senior lenders provide senior loans to companies. In an M&A transaction, the buyer, in addition to an equity investment, looks to lending institutions (usually commercial banks) to provide some senior debt to fund the purchase.
A senior loan in an M&A transaction is similar to a first mortgage on your home. In the event of default, in this case, the senior lender is the first to receive payment from any liquidation value of the purchased company’s assets.
Unlike angel investors, VCs and private equity groups who typically make pure equity investments in companies, mezzanine lenders provide subordinated debt to the company, often with the potential for equity participation through convertible debt. Mezzanine loans can also be sought for company growth or meeting working capital needs. However, in M&A transactions, mezzanine companies frequently team up with strategic and financial buyers to bridge the gap between equity and debt. Mezzanine loans are similar to a second mortgage on your home.
Since mezzanine lenders are behind senior lenders in the bankruptcy process hierarchy upon default, mezzanine investors look to invest in companies with solid historical cash flow, which enables the company to pay the required interest on the loan.
Many large institutions offer mezzanine loans for M&A transactions of various sizes. However, small business investment companies (SBICs), government-sponsored entities, also provide mezzanine loans to small M&A transactions.
Merchant banks are simply investment banks that are willing to invest some of the firm’s capital as an equity investment in a transaction in which they are also advisors. Some argue that there is an inherent conflict of interest in the merchant banking business model—a situation where the merchant bank is advising the seller (and therefore seeking to obtain the highest value for its client company) and acting as the buyer (and therefore seeking to obtain the lowest valuation). trying). The counter argument offered by commercial banks is that the firm believes in the deal and the future prospects of the client company to the extent that they are willing to invest their own capital to support the transaction. In most cases, commercial banks make small, minority investments.
Finally, having financiers for the seller is typical in M&A transactions. If the collective equity and debt provided by the buyer are not equal to the desired purchase price, the seller may be asked to hold a seller note to cover the funding gap. This is analogous to owner financing when selling your home.
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