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) and 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-binding
Memorandum 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
workarounds 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.”
Great insights. Don't oversimplify "synergies" for venture-backed/private equity backed companies. Deals bog down as much between an acquiring company and its investors as between a buyer and a seller. Acquiring companies will gladly and cluefully pay (but not overpay nor admit) for synergies for past performance + future combined prospects. Acquirers' financiers, often irretrievably clueless re. the same synergies, won't step up and pay because they're stuck looking at standalone math and can never reach consensus re. price.
Posted by: Andy Bane | June 25, 2005 at 10:51 PM