M&A – A Corporate Development Perspective
I recently asked my friend Daniel Benel if he’d consider contributing to my M&A series. Daniel was a banker with Lehman Brothers (in NY and Tel Aviv) an is now a corporate development exec at Verint Systems (NASDAQ: VRNT). Despite having never bought one of my companies, he’s a great guy with a smart corporate development mind (rim shot). I thought he could add a corporate development perspective to the series. I’ll make sure he gets copies of any comments that get sent back, or feel free to reach him at the hyperlink attached to his name above.______________ Below are three topics on my mind related to acquisitions from a corporate development perspective (perhaps the beginning of a series): The Hockey Stick Projections – Hockey Stick Financial Projections did not die with the bubble’s burst. Perhaps they were put away in the back of the garage for a while alongside other unloved sporting equipment like that confusing lawn bowling set or the ambitious NordicTrack. Unfortunately, some mischievous banker found the darn things, had them shined up and sent out to technology companies near and far. It is more likely than not nowadays, when I receive a book from a banker selling a technology company, that the financial projections show jaw-dropping out-year growth. The most noted reason for the turbocharged numbers: The Market. The Market is hitting a “sweet spot,” or the company is in a sweet spot and the market is about to develop a sweet tooth. These saccharine solution sellers expect, of course, to be valued off of forward numbers. My common response to wild growth projections is to advise the company not to sell. If management of a selling company believes that they can accelerate growth dramatically over the next 12 months, why don’t they prove the business plan and come back to the merger market with a significantly higher value? At this point in a discussion some sellers choose to revise their outlook. Other sellers claim that the projections are based on “what the company can do on a pro forma basis,” that is, when combined with “your more significant resources.” (I’ll discuss that in the “We Don’t Pay for Synergies” section.) Companies whose sales are truly going to accelerate dramatically, and are selling for a defendable reason, need to back up projections early on with a real sales pipeline/backlog (not a Frost & Sullivan report). Sharing pipeline/backlog data will immediately trigger competitive concerns in the mind of the seller, which is fair and will be discussed further in the “Overboard Competitive Concerns” section. We Don’t Pay For Synergies – Often stated as an acquisition truism, but not always true. In general, it is synergy that motivates an acquirer’s interest in a given target to begin with and not something for which a buyer is willing to pay extra. Synergy is a value that the transaction itself generates and is not produced by a company on a standalone basis. Depending on the transaction, each side may lay philosophical claim to a greater share of this value, but this debate will not affect the standalone valuation an enterprise can demand and is usually a losing negotiation point anyway. That being said, the more synergy a given business combination offers to a buyer, the more that acquirer is able to pay for a business. While an acquirer may not admit to paying for synergies, in a competitive acquisition process, the acquirer with the most significant synergies (all things being equal) could write the bigger check. Sellers should negotiate accordingly with this knowledge in hand. Overboard Competitive Concerns – Acquisitions often occur between competitors. This is natural, particularly in early stage markets that are in a consolidation phase. It is important to recognize that the time it takes to sell a company is correlated to the speed of information sharing. I am not referring in this case to the relationship-building phase that can take months or years, but rather to the moment in a transaction when there is a meeting of the minds between seller and buyer and perhaps a non-bindingMemorandum of Understanding (or other term of art) in place. At this precarious juncture, just when you are tempted to think that some of the hard work has been done and you can put your Blackberry down for the night, sellers can become frozen with fear that all of their competitive secrets will be stolen during the diligence process and somehow abused. Sometimes this happens when they receive a buyer’s diligence request list and it is longer than the federal budget. Sellers must recognize early on that they will have to accept the risk of sharing sensitive competitive information with potential acquirers in order to get a deal done. Some data, though, may be deemed so sensitive that particular work arounds need be put in place in order to make diligence acceptable for both sides. Sometimes a two-stage approach to diligence (deferring highly sensitive material to when the deal feels more certain) can resolve concerns. In this case, it is important to first determine how critical a particular piece of sensitive data is to the buyer’s diligence process. It may be, for example, that the seller believes his source code is something that can’t be revealed to a buyer early in diligence and he therefore stymies a process, when in reality the acquirer might be far more interested upfront in a customer list than in source code (and would be willing to delay source code review to just before signing).
Sometimes competitive concerns kill a transaction, or at least slow it down to a degree that momentum is lost, which is a topic to be discussed in a subsequent post entitled: “Don’t Lose Momentum.”