Sabeeh Khan, Director of Corporate Strategy & Development, Syniti
When it comes to deal sourcing, there are three different types of methodologies: opportunistic, reactive, and proactive. Opportunistic can be described as not incorporating M&A in day-to-day operations but being open to a particular deal if it appears. Reactive is when you already have inbound deals and decks coming in from banks, board members, or advisors, and you react to these deals that already are out in the market. Proactive is when you do your own diligence and digging around to find prospects that may or may not be a fit.
The goal for most corporate development teams should be adopting a proactive approach to deal sourcing. Opportunistic deals are similar to reactive deals: they may or may not be a great fit. People who tend to approach sourcing with an opportunistic mindset usually do not think about M&A as part of their strategy, resulting in deals becoming more of a gamble. Those who have a reactive approach may be presented with an amazing opportunity but must compete with other financial buyers or strategic buyers. This makes the process an expensive ordeal for the company to go through.
On the proactive side, you can find companies that have not considered selling just yet, or companies that have never considered it at all. This provides an opportunity to build a relationship with the owner or the CEO of that company. A strong relationship is vital because when they do become ready to go to market, you will be one of the first phone calls that they make. With this approach, you can preempt a formal auction process and have an opportunity to get deals at a favorable valuation.
Have a CRM or some sort of pipeline management system on the front end. The goal is to keep track of all of the deals that are coming in from bankers along with all the prospects that you're digging up. Take the time up front to find out as much as you can about the business such as the leadership team, pricing, technology, etc. via Google, Crunchbase, PitchBook, Cap IQ, and other resources.
Once you have collected this initial data, start the process of reaching out and pinging the CEO.
The message should state who you are, why you are reaching out, and why that company would be a good fit with your organization. Be clear that it is okay if they are not ready to sell. The purpose of the reach out is to have a conversation, get to know each other, and build a relationship.
A CRM is important because you are going to have many leads. Hopefully, these leads bring other companies to the attention of your business team as it is possible they have not heard of them before. To accomplish this, have an administrative system in place.
Establish a drip campaign that follows up with the business owners. The campaign should follow up six months down the road, a year down the road, etc. Even if they are not interested in selling today, keep track of their progress. Ensure you continue to see how they are growing, congratulate them on big wins, and continue to take steps to build that relationship.
When it comes to deal sourcing, encourage business unit leaders to think outside the box. By being proactive and bringing ideas to them, they will outline their general business strategy.
Do not fall into the trap of only having a short list of 15 or 20 prospects that come to you from the business unit leaders and executive team.
The resources mentioned above can be used for prospecting, but another key task is ecosystem mapping. This involves looking at yourself as a company and identifying your products, services, features, functionalities, gaps in your core offering, and gap solutions.
The objective is to figure out where your weaknesses are and decide where and how M&A can help. Once you establish a clear overview of your needs, you can conduct a targeted search on all the companies that provide the products, services, and functionality you need. You can start to stack rank and figure out who you want to reach out to first or who would be the ideal kind of candidate. Other sources for pulling data include podcasts, forums, and press releases. To ensure its efficacy, you want to gather as much information as possible prior to sending a cold email.
If the prospect and your business team is interested, it is time to move forward.
Assuming that this is a more of an organic, proactive deal as opposed to an inbound deal led by a banker, there are a couple of stages to walk through.
Create a shortlist of items needed to come up with a valuation for the business.
The shortlist is typically 10 items needed to formulate a thesis, excluding the financials and other information about the organization. For example, if it is a technology firm being acquired for a piece of technology, the requests should center around their source code, roadmap, etc.
This information should paint a picture of how they could fit within the organization.
Other important questions are: How do they formulate the valuation? Is it revenue, revenue multiples, or an EBITDA multiple? And if so, how much? Once you have a ballpark range, reach out to the seller and say, “What are your expectations? What are you hoping to do? Are you hoping to just sell this business? Do you want to continue on with the business?”
Hopefully, you will receive their feedback and can form an idea of evaluation expectations. Perhaps they're looking to just sell and retire. If they're looking to stay with a company and watch it grow, then you can structure the deal a little differently. You can build an earn outs or maybe pay less upfront in cash and make that more contingent upon future performance of the business. All these factors impact valuation and transaction structure to an extent.
It is important to understand what the seller wants. For example, let's say that they want a certain valuation, 10 X or EBITDA. You can judge whether or not that falls within your range. If it falls within what you had expected, you can move forward. If it doesn't, immediately start the conversation of, “Here's what we were thinking and why. Do you still want to proceed and move forward?”
If they're happy with the number or with the range, it is time to start your formal diligence process. This is the moment to get other people involved within the company. There are typically different work streams for each functional area such as finance, sales and marketing, HR, legal technology, etc.
Depending on how large your company is, the size of this team may vary. In some cases, these same individuals are going to be working in both the due diligence phase and the integration phase.
Once there is internal approval from the business unit leader or team and the seller is ready to move forward with the next steps, ideally, it is time for them to sign an NDA. Sometimes, a seller may want the NDA before the introductory phone conversation. An NDA depends on the comfort level of the seller. It is important because it reveals confidential information about their business to you. This can include their financial information, customer information, contracts, strategy, etc.
You want them to share everything with you, but also want to make sure that they understand that the information will not be turned around and sold to a data provider.
One approach to take is before submitting the short list of items needed for valuation, have an NDA in place so that both sides are covered and comfortable. Then it is time to ask for items such as financial statements, invoice register pipeline, information around technology, and other similar information.
After you have the short list of items that lead to a valuation number (and one that the seller is comfortable with), then it is time to submit an LOI or letter of intent.
The LOI is non-binding and the purpose is to lay out the valuation, the transaction financing plan, high-level information about the plan for key employees/ executives, why the company would be a good fit from a strategic perspective, and other similar matters.
Its purpose is to provide high-level deal structure information. Questions to consider are: Is it going to be a stock deal? Is it going to be an asset deal? What's the governing law going to be? Is it going to be the governing law of a particular state in the US? If it's an international deal, is it going to be U.S. law, or is it going to be the seller's home country’s law? The LOI is also where to ask for exclusivity. This prevents the seller from going with someone else’s bid after your team spends time on diligence, investing money, and working towards a deal.
The LOI covers all of those topics at a high level. If it is a banker-led process, they may ask for LOIs at a different stage or may ask for initial indications. If it is a two-step auction process, there will be initial bids that are put out called indications of interest.
Next, they will narrow the field down to maybe four or five different buyers, followed by a deeper diligence. Next, they will narrow it down to one or two buyers and the LOI stage. Those one or two potential buyers will have exclusivity.
The exclusivity period is typically 30 days or 45 days where they are not allowed to negotiate or talk to anybody else. You are the only buyer they are going to negotiate with. During this period, bring in your broader team from all various functional workstreams: finance, legal, IT, etc.
Have a kickoff call first with the internal team and discuss where you are in the process, what conversations have been had with the seller, and the due diligence cadence for moving the process forward.
Pull together a broader list of diligence questions and provide this information to the seller to let them know what you plan to run through during diligence.
In the kickoff meeting talk about the key questions for the investment thesis that answer why you're looking to acquire this business.
This is when to bring up the most important topics that you want to hit upon. Do you want to talk about the timeline of the transaction? Do you have 30 days to close or 60 days to close? If it appears they have a weak sales team, ask why sales haven’t been hitting better marks. If there's an issue with technology, dig in a little bit closer on the technology side. Just be sure to orient your team so they know what to look for and the types of questions to ask.
At this point, one option is to have weekly check-in calls with the internal diligence team. Depending on the size of the team, you may want to have a separate call for each functional work stream.
You can also have at least one high-level call a week where all of the leaders get together and quickly walk through what they discovered in diligence during the last week. These calls typically do not need to be more than 30 minutes. Everyone can bring up areas of concern, talk about what they have coming up, identify any bottlenecks, and discuss if there are some items that might require collaboration.
Another option is to set up an external check-in call, sometimes just with the seller, to make sure that the deal is progressing to close and everything is being taken care of in a timely manner.
About halfway through diligence, when you’re fairly certain that the deal's going to close, start to loop in the integration team. Three to four weeks before closing start to draft communication documents. This includes a FAQ for employees both on the buyer side and the seller side. You may even have a FAQ for customers as well. In addition, draft a customer communication document, a plan for how to communicate with customers. Certain customers are going to be key, and the seller is going to make special efforts to reach out to them. Put the marketing team in touch with a seller to draft those documents to create that plan in tandem.
On the internal side, work with marketing to make sure the documents go through the requisite approval process. The documents may need to be run by the business unit leaders, the executive team, the CEO, legal team etc. and then edited again. Once you are happy with the documents and ready to send it out, ask the seller for edits.
This is also the time to draft any press releases. It is important to start these communication documents early on so that once the deal closes, it is just a matter of executing on that communication strategy. If there is a board of directors or investment kind of committee, keep them regularly updated on the process. It is important to walk them through the findings of diligence, any key issues that have been identified, and how to mitigate risks.
Lastly, it is important to do one final run through prior to closing to thoroughly go over what was discovered during diligence.
During the weekly diligence check-in meetings when all work stream leaders are in one place, use that opportunity to gently put people on the spot.
Everybody should give their own readout and hopefully the CEO, or other executive team members, are on that call as well. Use that opportunity to say to those on the call, “Here are our requests, objectives, what we were able to do, and what we're still stuck on. Can you provide us some color about what else the corporate development team can do to assist you in achieving our goals?” This creates accountability and keeps everyone on track. If they are not as responsive on a day-to-day basis or on a week-to-week basis, it puts a gentle spotlight on them.
Be sure to remember that not all work streams are going to play in equal part. It all depends on the deal. For example, if your rationale for acquiring a company is cost synergies as opposed to revenue synergies, their sales pipeline is not as relevant to you as the technology side. Your head of sales might have a conversation with their head of sales to gather some information on pipeline and growth numbers, but you're probably not going to dig too much into the sales metrics. You will be more focused on either the tech or the employees, depending on what the thesis for the deal is.
Pressure the team to go ahead and complete their diligence right out of the gate because you don't want to spend time chasing people down later on in the deal.
When it is time for closing, the legal team will draft a purchase agreement and disclosure schedule. If there's a transition services agreement that needs to be drafted, they'll take the lead on that as well.
Make sure the data room has all these documents, especially if there are references to specific customers or contracts in either the disclosure schedules or in the purchase agreement. Check that the information is consistent between the data, purchase agreement, and disclosure schedules.
At this stage, it is time to make final edits and submit your purchase agreement. As you start to check off all the items on the diligence request lists, schedule a call with the board or investment committee three to four days before closing. It’s usually a short presentation deck that includes what we found, issues that we uncovered, plans to address those issues, the business on day one and on a go-forward basis, and the final evaluation.
If there were any changes to valuation, this is where to get the final approval from the board before submission. Then begins the process of handing everything off to the integration team. In some cases, integration works hand in hand with the corporate development team. Integration can also report to the corporate development team. In other cases, they are just a whole separate arm that is operated by the business unit that is absorbing the company.
While there are different approaches to take, the bottom line is that it falls to the corporate development team to remove roadblocks for the integration team and have difficult conversations with the seller. For example, if there was a plan to fire certain customers, this would be the time where you bring that up.
HR should be meeting with the employees of the acquired company on day one, post-close. The reason for that is because there's usually a lot of fear amongst the employees of the company that's just been acquired. When they walked into the office that morning, they just found out that the company has been acquired and have no idea what it means for their jobs, livelihood, and families. People may have moved recently for the job and they need to be clear on what it means for them. Again, hopefully, you've had a good communication strategy in place. This is the time where you would distribute your FAQs to the employees. The employee communication is typically delivered by HR as well as the business unit leader or your CEO.
You want to talk to those employees about benefits and compensation and what it means for them. If you think that down the road there are going to be some employees laid off, this is when you let folks know that you haven't necessarily made a decision yet on who's going to stay on.
The objective here is to prevent an exodus of employees immediately post-close. Prep your sales team and have some account managers ready to go as well. They need to be ready to take inbound calls from customers that are confused because typically one or two days after employees are informed, customers are also informed. Key customers are usually given a phone call. Your sales team has to be ready to manage those concerns and conversations. You should have a monthly internal meeting in addition to your weekly meetings with your integration team. This should be a monthly steering committee meeting where you fill in all your executives on the status of integration. Where are you from the technology perspective? Where are you from a people perspective? Where are you from a sales perspective? Are sales metrics that people need to meet? I have this type of meeting once a month, and then on a weekly basis.
The end of integration really depends on the objective of the deal. If there is a transition period, then there'll be whatever is outlined in the TSA. If there's an earn-out involved, your integration period might be a year or so based on the specific language used. The end of integration really is once all the streams can come back to you and say, “We've completed all the tasks that we had set out for ourselves at the get-go. The technology has been integrated on the backend. Customer migration has been completed. Billing is all done, branding and marketing updates have been completed.”
Integration could take up to a year or so, and in some cases could potentially take longer. Generally, the benchmark is around a year. I like to be done with integration twelve months post-close at the latest. After that, the corporate development teams need to make sure that progress is tracked.
You want to be able to provide metrics a year or two later and say, “Here's the revenue and EBITDA for this company that we acquired. Here's what their pipeline looked at when we acquired them and here's how we look a year on or two years on.” Afterwards, you can determine whether the valuation that you came up with was the right valuation. Was it worth it? Was it a good investment? If you find that the company has more expenses than you anticipated, or the revenue didn't go quite as fast, then you identify why that is. But you need to be able to have numbers so that you can go back to your leadership team and show them how the business has progressed.
There are three higher-level deal stages:
In the pre-deal stages, you are creating and defining your business strategy, defining an MNA strategy to support that business strategy, and conducting the deal sourcing. This pre-deal process could take six months. In some cases, this can extend to one to three years. Equally, it could be quick and take a month or less. It’s an ongoing process that you incorporate into your day to day. You never stopped sourcing. There’s going to be times where the economy affects progress or market conditions affect your ability to get deals done.
The deal stages, which include diligence, valuation, and negotiation, can be as short as 30 days or as long as 60 days. The objective for most people is to shorten that window as much as possible. Try to do it within 30 to 45 days as deal fatigue sets in pretty quickly for most people on both sides of the transaction. Under particular conditions, it could drag on for four to five months.
The post-deal stage, which involves integration, employee retention, customer retention, integration tracking, and interaction evaluation, could take up to a year or more. Retention and transaction evaluation can take two to three years post-close. It just really depends on what you define as your evaluation phase.