Chapter 8 provides an overview of corporate development and the buy‐side from the perspective of the strategic buyer. While conceptually similar, this chapter looks at the buy‐side through the lens of M&A advisors and emphasizes certain details relevant to them. We will use Figure 9.1 (first seen in Chapter 8 as Figure 8.2) as the baseline process for this chapter, keeping in mind that there are many variations. This chapter is meant to augment the content of Chapter 8.

BUYER CLIENTS

In general, there are two main types of buyers that may engage an M&A advisor to assist in the acquisition process: financial buyers and strategic (corporate) buyers.

Some buyer‐clients are very sophisticated and all they need is to get access to the scarcest resource: the appropriate target company, with a willing seller. These sophisticated buyers (such as private equity funds or well‐staffed strategic buyers) have the in‐house resources to quarterback and execute on the deal process, including negotiating offers, managing due diligence work streams, arranging outside financing (if needed), and structuring and negotiating the definitive agreement documents with professional legal assistance. On the other hand, there are less‐sophisticated or shorter‐staffed buyer clients who need a lot of buy‐side assistance from an M&A advisor. There is a wide range between these two extremes. The M&A advisor must assess the needs of the client and determine whether the assignment is a fit.

Financial Buyers

• Private equity (managing a committed fund)—seeking platforms
• Private equity (managing a fund)—seeking add‐ons
• Independent sponsors (not managing a fund)
• Family offices (proprietary capital source)

Strategic Buyers

• Private company buyers—seeking growth acquisitions
• Public corporate buyers—seeking strategic acquisitions

STRATEGY

As introduced earlier in this handbook, an acquisition is ideally the result of choosing the best alternative to accomplish a strategic objective or fill a gap; in reality it can meet a number of goals if approached and executed as part of a long‐term growth strategy. The maturity of the strategy of the client company, the stage of the business, and where the M&A advisor enters the process with the client dictates the scope of the M&A advisor's engagement and what needs to be done.

To be effective in leading a search process, there needs to be a defined set of criteria that can be agreed on by management, the board, and the acquisition team. There are many ways of getting to this set of criteria, keeping in mind that the following are typically part of the planning and preparation:

• Clearly understand the current shareholder objectives.
• Define the future market position of the client company (three‐to‐five‐year horizon).
• Develop a consensus around the current status and position of the client company.
• Determine the gap or missing capabilities, resources, and so on, to get to the future position.
• Agree on the size of acquisition that is practical.
• Agree on the valuation approach.
• Agree on the desired (ideal) integration method.
• Develop a financing strategy.

If the buy‐side assignment is on behalf of a buyout private equity firm, the criteria are likely already established based on the investment thesis (or theme) of the fund. Following are sample investment criteria for a private equity firm seeking acquisitions in the lower‐middle market:

• Niche manufacturers of industrial products or specialty services companies (B2B)
• Revenues: $5 million to $50 million
• EBITDA: $2 million to $8 million
• EBITDA margins: 10% or higher
• Companies that are leaders in their industries and have a high regional or national market share
• Good growth opportunities (either organic or strategic add‐on acquisition)
• Diverse and stable customer base (customer concentration <20%)
• Strong management
• Geographical focus within the continental United States

Most of the process in Figure 9.1 will be the same for a private equity search, but there will not likely be a 100‐day integration plan.

If the search project is for private equity and the target is a bolt‐on acquisition for an existing portfolio company, the process will be the same as illustrated in Figure 9.1 and discussed in Chapter 8.

THE FILTER

The criteria for the target acquisition can be embedded in a decision matrix that allows the team to test various targets for fit. This decision matrix is sometimes called the filter or screen. One approach is to begin with a broad filter using market feedback and the vetting of a few actual deals to more clearly define the desired target, and then narrow the criteria and develop a short list of companies to be approached.

This two‐step method allows the M&A advisor to ensure that the client's expectations are aligned and that there are no missing or underlying assumptions that did not get documented in the first iteration. It helps prevent wasted time for the M&A advisor and can improve responsiveness to the client.

FINANCING

When financing is required, it takes time. Financing sources, both debt and equity, can be approached once a coherent growth strategy can be articulated with a defined filter. The objectives are to:

• Broadly determine the level of interest by the financing source.
• Validate the financing strategy being contemplated.
• Build a relationship with the client's management and the funding sources seeking an acceptable fit.
• Develop a short list of potential funding sources that will be accessible and support the acquisition process, providing feedback into the vetting of targets.

Combined, these actions allow the client and the funding sources to filter in (or out) what works for them and to buy into the eventual transaction being shaped by those who are likely to be the check‐writers, and align expectations along the way.

In some instances, it will be necessary to obtain a soft commitment letter (or comfort letter or indication of interest (IOI)) before signing the letter of intent (LOI) to provide the seller with evidence that financing is available for funding the acquisition. Obtaining a commitment letter in short order is practical only if the funding source has been part of the process long enough to be comfortable with the acquirer's management, strategy, and plans; thus this is another reason to engage the lenders and investors as early in the process as is practical.

Chapter 15 provides information on financing strategies and how to fund an acquisition.

QUALITY OF EARNINGS

Audited financial statements primarily focus on the balance sheet to ensure that the beginning balances and the ending balances of all the assets and liabilities are materially correct. This is not to imply that there is not scrutiny of the income statement by the target's auditors, but that is generally at a much higher level than is needed to adequately understand a target's business model. In most cases, there can be period‐to‐period changes in earnings and other fluctuations that are not revealed by an audit and may be of significance to a deal. Business valuations and some transaction financing are predicated on a certain level of available cash flow based on the core earnings of the underlying business. Although a review of audit working papers is often a part of a quality‐of‐earnings assessment, it is only used as a starting point for further, more forward‐looking analysis.

A quality‐of‐earnings assessment (QofE) is conducted to fully understand the historical revenues, cash flow, and earnings. Although one benefit of such an assessment includes the clarification of any accounting anomalies, a thorough assessment should result in a number of other benefits, including the following:

• Identification of concentrations of risk, including reliance on large customers, sole‐source vendors, or key employees
• Quantification of the effect of trends in product pricing, volume, and sales mix on the target company's revenues and gross margins
• Analysis of the working capital needs of the business to better understand operating cash flows
• Identification of unusual and nonrecurring items of income and expense that need to be removed to assess the underlying cash flows of the target going forward
• Comparison of accounting policies used by the target with those of the acquirer to better understand the effect of the acquisition

Even though a QofE focuses on the historical performance of the target, its true purpose is to gain insight into the target's future operating results and cash flows. This is seldom the focus of an audit, except when there is an indication that the target will not be able to continue as a going concern.

One strategy to manage the professional fees associated with an acquisition is to have the buyer initiate a quality‐of‐earnings assessment quickly after signing the LOI, providing insight into what can be a deal‐breaker if the expected trailing 12‐months EBITDA is materially different from what was presented by the target, or if the risks associated with repeating and growing those earnings are much higher than those assumed when the LOI was signed.

When the target company has a sell‐side advisor assisting in the sale of the business, that advisor may insist on hiring a sell‐side quality of earnings expert to do a review prior to bringing the company to market. The buyer will ultimately do their own QofE (either completely or on a confirmatory basis), but the sell‐side QofE aids the seller because it reduces the possibility of repricing the deal post‐LOI based on the buyers QofE findings.

From the perspective of the M&A advisor, eliminating potential deal‐ breakers quickly can help keep the pipeline full with other targets and increase the likelihood of achieving the client's objectives and timelines.

Chapter 16 has additional discussion about the quality of earnings and due diligence.

COORDINATION

The buy‐side advisor can assist in back‐channeling information with the sell‐side during the time leading up to the exclusive LOI. Many times sellers or their advisors will divulge important but seemingly innocuous information to a buy‐side advisor who is not the principal buyer.

As in the sell‐side process, the M&A advisor in the buy‐side process needs to manage the process, manage the timelines, coordinate activities, and assure that momentum is built and sustained. This is particularly true after the LOI is signed and where the activities are clearly in the hands of other team members and third parties.

INTEGRATION

For acquirers, closing the transaction is only the beginning of the next chapter in the life of their business. For some M&A advisors, the closing will be the end of their involvement. For others, their involvement may continue by supporting the client during integration and/or seeking the next target or investing in the target company.

Best practices show that integration planning needs to begin early in the acquisition process, even before due diligence. As indicated in Figure 8.2, it is valuable, and increases the likelihood of success, to have discussed integration and the potential impact of a deal at the outset of the initiative and to establish a framework from which to act as the acquisition process unfolds. The key is to continually align the decisions, actions, communications, and incentives with the long‐term strategy and objectives, keeping everyone in the process on the same page, eliminating surprises, and setting realistic expectations.