M&A advisory practices have evolved over the years and have become distinct firms with specialized skill sets and processes. Many of these practices were created as divisions or spinoffs of other related firms such as accounting, valuation, legal, or industry consultants. Others migrated upstream from business brokerage or downstream from larger investment banking operations. Today, the best and most sustainable M&A advisory practices that serve the middle market operate with devoted staff, technology, and specialized skills aligned to the needs of these sellers and buyers.
Clients in the middle market may initially reach out to the professionals they routinely engage, like their attorney or accountant, to assist with their transactional needs. Frequently clients quickly recognize that they need assistance from a professional who specializes in these types of transactions, rather than one who might have tangential experience. A quality M&A advisory practice will be able to act as the financial strategist, the marketer of the business, the deal finder, and, when advising the buyer, the leader of due diligence. Some of the less obvious roles that M&A advisors play include consulting to help improve business performance and prepare a company for sale, offering integration assistance in combining two businesses, providing education, and tempering valuation expectations, or acting as financial advisor to view the business within the context of the seller's overall personal portfolio.
The successful sale and transition of a company normally takes a multidisciplinary team. The team lead is typically an M&A advisor who has devoted their professional career to serving in the capacity of a quarterback with a holistic view of the process. Part of being an M&A advisor involves leading and coordinating other professionals, those routinely involved as part of the M&A team:
This chapter will define the role of an M&A advisor serving the lower‐middle market and will address the issues encountered in building a successful practice.
Traditionally, private business owners are served by one of three types of transaction intermediary: business broker, M&A advisor, or investment banker. Each of these intermediaries can play a role in the transfer process based on the size, market, and characteristics of the target company, as shown in Table 6.1.
Secondarily, some business brokers help individuals seeking to purchase a business, find a target, obtain bank financing, or negotiate a deal. But they often perform these functions for buyers with the ultimate goal of completing the transaction for their selling client.
TABLE 6.1 Comparison of M&A Advisors
Characteristic | Business Broker | M&A Advisor | Investment Banker |
---|---|---|---|
| <$5 million | $5 to $250 million | >$100 million |
| Mostly Seller | Both | Both |
| Yes | Rarely | No |
| No | Maybe | Yes |
| No | Yes | Yes |
| No | Yes | Yes |
| No | No | Yes |
| No | No | Yes |
| No | No | Yes |
| Listing | Negotiated/Private Auction | Public Process |
Investment banking is a term generally (but not exclusively) used for those holding a license specific to the sale and exchange of company securities.
Given the holistic role of the M&A advisor described herein, the M&A advisor is in a unique position (relative to the business broker or investment banker) to add significant value in preparing a company for sale, leading the transaction, ensuring that the structure and nuances of the deal elements are aligned with the seller's needs, and then supporting post‐closing activities.
A common misconception by sellers is that the highest value of the intermediary is finding the buyer. Feedback from sellers after closing a sale transaction led by an M&A advisor reveals that the highest value provided by the M&A advisor was:
It is notable that identifying and finding the buyer was last on the list of value‐added items.1
One of the biggest challenges for an M&A advisory firm is identifying clients and obtaining engagements. Technical skills and ability to perform do not necessarily translate into deal flow or a paying client. It takes continuous and persistent marketing and networking to sustain a practice.
Traditional marketing methods might suggest that building a brand or marketing directly to your prospective clients is the best way to attract future clientele. Unfortunately, prospective clients of M&A advisory services are not making typical consumer selections. Rather, engaging an M&A advisor is often a once‐in‐a‐lifetime event and therefore only relevant for a small fraction of the business owner population at any time. As a result, marketing directly to business owners may fall on deaf ears 95% of the time and may not even influence decision making when those individuals encounter an event that warrants engaging an M&A advisor.
In contrast, advisors may find more success by building brand awareness and cultivating trusted relationships with the “authorities” who have influence on the selection of M&A advisory services. Those authorities are trusted individuals, often professional services providers, who know business owners and are likely to be in close touch with them when the owner becomes interested in doing a transaction. It is important to build brand awareness and market directly to these “centers of influence.”
One of the most important activities for an advisor attempting to develop new business is networking. As just noted, an advisor must interact and build relationships with professionals in a position to refer transactional clients. Typical referral sources include attorneys, CPAs, other investment bankers, private equity investors, commercial bankers, friends, and previous clients. There is no substitute for referrals from those who have worked with your firm and had success. Good work begets good work.
Professional networking through trade and industry associations, family business and entrepreneur groups, and other business owner forums is valuable. In addition, farming existing relationships with personal contacts or contacts from a prior career can be beneficial. Deals can come from unexpected sources, and an M&A advisor should use communication with friends, neighbors, former coworkers, and even family as an opportunity to build on a network. Social media may augment face‐to‐face meetings, staying top of mind within an existing network of relationships, while also making new contacts.
In an attempt to expand a practice, advisors may employ some traditional marketing techniques; however, this should be done with caution. Advertising, publicity, cold calls, direct mail, and unrelated sponsorships may help build a trade name and create greater market awareness but may not actually result in direct referral of clients or actual deal flow. Collateral materials that are more educational in content, such as white papers, topical blog posts, videos, brochures, websites, and articles describing the transaction processes or current market conditions, are often useful in selling services and informing clients of the value of the advisor and his firm. Small group seminars, articles, speeches, and proprietary research are often the most effective means of creating deal flow for professional service providers.2 Many business groups, such as family business associations, regularly look for outside speakers for programs for their members.
Offering seminars or webinars on exit planning or valuation is a good way to attract private company owners who are considering selling or transitioning their ownership. Those who take the time to attend these types of seminars, or even to respond, may be good targets. For clarification, large pressure‐sale seminars are not recommended. Abuse of this tactic has a tainted history in the M&A business and will likely create the wrong image of the advisor and firm.
Offering pretransaction consulting services, as described in Part Two of this book, can enable a client to engage early with an advisor, allowing both to build a relationship. In the process, depending on the firm's skills, the advisor may provide assistance in planning for an exit or the monetization of the client's business; improving the client company's performance and hence its value; or growing the business, which may include an acquisition.
Often sellers want to start the sale process by first understanding the value of their business. Others are approached with an unsolicited offer from an acquirer in their industry and seek a third‐party valuation opinion. Still others, such as those who have contemplated selling their company to employees or family, may start the process by retaining a valuation expert. All these options can make sense. For M&A advisors seeking to attract sell‐side clients, with sufficient information and experience, it may be helpful to offer valuation services without the opinion, which is in effect an informal market valuation. Providing a formal valuation that can be tested in court is often neither required nor appropriate for an M&A transaction. In the event that a company owner actually needs an opinion of value (e.g., in a divorce, legal dispute, Employee Retirement Income Security Act reporting, etc.), the M&A advisor can refer the client to a technical valuation expert.
Business coaches, industry specialists, financial planners, and CPAs are in a prime position to assist a company with the sale of its business or the purchase of another. Often, these professionals are already trusted by the client; they know the business and may have other industry contacts to make a match and subsequently enable a transaction.
For these reasons, many CPA firms and other consulting practices have established M&A advisory practices to capture these internal referrals and convert consulting relationships into M&A engagements.
Another effective way to build a professional network and promote services is to become known as an expert in a particular industry or segment. M&A advisors who have multiple successful transactions in a particular industry can leverage their success to attract similar deals. Coupling promotion of successful transactions with client referrals; speaking at industry events and meetings; hosting webinars; publishing blog posts, articles, research results, white papers, and books; and attendance at conferences and trade shows can result in establishing a reputation as an expert and a go‐to resource for M&A services.
A client may wish to engage you, and may even be willing to pay you. But are the client's goals realistic? Take time to assess a potential client's needs and expectations. High‐performing advisors view time as a key resource that is to be managed and they do not waste effort on unrealistic opportunities. A common area of disconnect between the advisor and the client exists regarding valuation and timeline, as discussed later. Before those discussions, it might make sense to educate the client or ensure that the client understands the types of transactions available. Some are listed here along with questions to consider. The implications for the advisor are that some analysis and preparatory work are required before the engagement. The advisor should facilitate a meaningful discussion and provide some initial recommendations and observations.
Discussing these strategic questions with a potential client upfront will help ensure that the M&A project undertaken is appropriate for the circumstances and has a chance to be successful. This can save both the advisor and the client time and money.
Confidentiality may not come naturally to clients but is necessary for a successful transaction. Untimely disclosure of a transaction to employees, customers, vendors, and the open market could have negative impacts on the business or jeopardize the transaction itself. An M&A advisor should stress that they will do their part to keep the deal quiet. However, clients need to be advised on the importance of keeping their own plans strictly confidential. Many confidentiality leaks can be traced to the sellers (or employees) themselves, family members, or existing service providers.
Clients will typically identify key employees who will be “in the know” with respect to a transaction. These employees should be coached on appropriate confidentiality and corresponding procedures. In addition to keeping quiet with coworkers, they may need to use extra caution while communicating with outside parties, such as sales reps or other industry insiders, who are not under the same obligations of confidentiality as the employees.
Advisors should also discuss the confidentiality rules of the road with their clients. Is sending e‐mails to the president's company address acceptable? Or should the client establish a secure or special e‐mail address? What about phone calls and voice messages? Too many phone calls and messages from Joe M&A Advisor will soon leave employees with little doubt as to the company's plans. Create agreeable methods of communication and the rationale for why the advisor will be asking for company information. Sometimes, M&A advisors will be introduced to the company's employees as consultants, auditors, bankers, or insurance/bonding agents.
Finally, the advisor should discuss the inevitable question a seller will be asked by a friend or colleague sometime during the process: “I heard that you are selling your company?” The seller has likely been asked this question a few times before but has never been sensitive to the issue until now. Of course, a startled response, such as “Where did you hear that?,” is mere confirmation for the inquisitive friend. Therefore, prepare the seller with a response. An example could go like this: “Of course, we are always for sale—why, are you interested in buying?”
An engagement letter or agreement is usually drafted after arriving at a mutual understanding of realistic expectations regarding value, timeline, and goals. This engagement letter should set forth the understanding of services and fees between the client and the M&A advisor. A typical engagement letter will include the following provisions:b
It may seem obvious, but the first question an M&A advisor should ask is, “Who is my client?” Is it the company? Is it the shareholder(s)? What if there are multiple shareholders with different goals and objectives? In some cases, these are straightforward, as in a single‐shareholder company looking to sell. However, in other cases (like partner buyouts or disputed sales, and in multigenerational family businesses) the answer may be a little opaque. In an acquisition where the advisor is on the buy‐side, the client is typically the company.
The second question to ask when identifying the client is: “Who is authorized to engage me on behalf of the company?” Again, often it is obvious, but some situations (such as a divisional vice president asking you to help divest a part of the company) may not be as straightforward.
M&A advisors may want to engage their own legal counsel to help them understand the nuances of contracting their services in these more complicated situations.
The engagement letter should set forth the actions that the advisor is intending to take for the client and define an expected timeline. In some cases, the advisor may want to specify which services will not be provided. For example, it might be appropriate to disclose that the advisor will not be responsible for preparing financial statements, schedules, or forecasts that need to be generated by management. The engagement letter should also spell out the role and responsibilities of the client, such as what information will be made available to the advisor and when that information should be expected.
When describing the timeline, it is generally best to reference the steps in the process, rather than hard dates. For example, “M&A Advisor will provide Seller a draft of the marketing book within 30 days of receiving the information requested from Client.”
Here are some example timelines and defined milestones for a sell‐side engagement:
As with any legal contract, there should be provisions to protect the advisor from liability. Typically, these include specific limitations or exclusions of services being performed by the advisor as well as indemnification by the client in favor of the advisor in the event of third‐party claims that arise from things other than the advisor's own negligence. Some M&A advisors obtain errors and omissions (E&O) insurance to further protect the advisors and the firm. It may be helpful to have the insurance underwriter review the indemnification language in the engagement letter so that it aligns with the E&O coverage terms.
Again, it is advisable for M&A advisors to consult with their own counsel in developing the standard language they will use in engagement letters.
Most middle market M&A advisors will structure a selling engagement with a mix of fees as follows:
The up‐front fee charged by advisors is sometimes referred to as a retainer; the implication is that this is to be applied against the ultimate success fee paid at closing. Some advisors have begun to refer to the up‐front fee as an advisory fee instead of a retainer to send the message that this is a separate fee for services and is therefore not applied against the later success fee. As an alternative to the up‐front fee, it is also common to obtain a monthly fee for the duration of the engagement plus a success fee.
Some advisors use milestones defined in the scope of their engagement to cause up‐front fees or retainers to be paid. For example, fees might be staged and paid upon completion of the following events:
The success fee can be calculated in any number of ways, but typically is a percentage of the purchase price upon consummation of the transaction, paid out as the sellers are paid. The percentage used will vary, based primarily on two factors:
For example, business brokers will often charge 8 to 10% for selling a business with a value under $2 million. A broker working purely as a “finder” for a buying client might charge a 1 to 5% fee for transactions ranging from $5 million to $20 million. Investment bankers typically charge 2 to 5% for lower‐middle market transactions of $5 million to $50 million. And those same investment banking firms may charge 1 to 3% on transactions of $50 million to $200 million.
M&A advisors and business brokers in smaller transactions that are commission‐only engagements may use a formula commonly known as the Double Lehman, named by doubling the original formula created by the former investment banking firm Lehman Brothers in the early 1970s:
Most middle market advisors will establish their success fee based on a total value amount (TVA) percentage or aggregate consideration. TVA success fees are set as a fixed percentage based on the expected valuation or sale price and generally assume that there is some type of retainer or advisory fee involved. Middle market advisors' success fees approximate the following:
Other fee structures have become popular with M&A advisors and are often used to enhance or replace more traditional fixed percentage success fees. Some other structures to consider include:
In most middle‐market engagements the fees are applied to the known or secured enterprise value determined at closing. This would normally include consideration that is deferred due to promissory notes, escrows, holdbacks, or rolled‐over equity in the buyer's company. Standard purchase price adjustments for items like working capital will not typically affect success fees. On the other hand, M&A advisors will typically collect fees associated with contingent portions of the purchase price (earnout) at the time it is paid to the seller. This aligns the advisor's interests with their client's, to advocate for proper calculation and payment of the contingent value.
Engagement letters should also include termination provisions that allow both parties to terminate the services of the advisor. In most cases, the client would be the one requesting the termination, either because the client is unhappy with the performance of the advisor or no longer wishes to proceed with a transaction. Most termination clauses require advanced written notice.
To prevent clients from terminating an engagement letter with an advisor purely as a means to avoid paying a success fee, so‐called tail provisions are generally negotiated into the terms of the agreement. Tail provisions indicate that the advisor is entitled to the success fee if a transaction is completed within a certain time after termination. Normal tail provisions continue for 12 to 24 months following termination and may apply either to any transaction or only to transactions with parties identified at the time of termination.
Buy‐side engagement contracts should begin by gaining an understanding of the maturity and status of the client's strategy so the M&A advisor can scope the engagement and estimate the amount of time and resources required.
The outcome of a buy‐side engagement for an M&A advisor is typically less predictable than that of a sell‐side engagement. Conceptually, it is difficult to predict whether a client will actually make an investment or acquisition even when presented with an ideal target. This is unlike a seller who makes a decision to transition from the business, where there is usually a significant emotional commitment that builds as the deal progresses and seems to increase the likelihood of closing as the potential to sell manifests itself.
Accordingly, buy‐side engagements typically have significant monthly retainers with some form of success fee to be awarded based on achieving the client's objectives. Out‐of‐pocket expenses are paid as incurred.
The buy‐side engagement is fraught with difficulties in getting completed (and therefore requires a retainer to entice most M&A advisors to help the buyer). This is mostly because the advisor may (or may not) be exclusive to the buyer, if not exclusive to the deal. Whereas the advisor gets paid if anyone buys the target or any deal is done in a sell‐side engagement, in a buy‐side engagement, there is often a lot of activity, but no deal to show for it at the end of the work. These deals tend to die near the goal line.
Some M&A advisors, especially those who source platforms for private equity groups, have learned that they can garner co‐investment rights in deals. There can be benefits to negotiating for and exercising these co‐investment rights. First of all, there are no fees associated with them. Second, co‐investment endears the advisor to the private equity client and creates the basis for an ongoing relationship. Third, if the investment works out, it can significantly enhance the advisor's income over time.
In some instances, individuals who are active in certain types of M&A transactions need to be licensed as broker‐dealers according to federal laws, including the Securities Exchange Act of 1934, and certain state securities laws. See the “SEC Provisions Regulating Broker‐Dealers” and “FINRA Provisions for Broker‐Dealers” sections in Chapter 19 for additional discussions about this topic.
According to informal surveys within the industry, 50 to 60% of M&A advisors in the lower‐middle market are not securities licensed. Conceptually, this makes sense given that many small transactions are asset sales that generally do not involve the exchange of securities. The percentage of deals structured as asset sales diminishes as the size of transactions increases beyond an estimated $100 million. These larger deals are more likely to involve stock sales and other consideration that may be considered a security and clearly require securities‐licensed investment bankers to facilitate the transaction.
Within the business of mergers and acquisitions, there are varying opinions about the actual licensing requirements given that the securities laws were originally written during the 1930s to protect public investors in the publicly traded stock markets. Over the past 20 years there have been a number of initiatives to provide clarity and reduce the ambiguity regarding the law and its application within the M&A business. In some instances, the SEC has issued no‐action letters, and in general there is very little case law to rely on.
To some degree, there are benefits of being licensed even if the transaction does not require it. For example, in the eyes of some clients the status of broker‐dealer implies a level of credibility greater than that of an unlicensed intermediary (although in practice this is not necessarily true). States' business licensing requirements vary for consideration beyond securities compliance; the state level securities laws are referred to as blue‐sky laws (see Chapter 19). There are some relatively serious penalties for noncompliance with federal and state laws depending upon the situation, enforcement, and the state. For the M&A advisor, some of the potential hazards of noncompliance include denial of compensation, fines and penalties, rescission of the transaction, and personal liability for associated costs in the event of rescission. For the client company, noncompliance risks include potential rescission of a transaction and denial of a clean legal opinion on future securities transactions.
The following list provides a few strategies for complying with the current securities laws:3
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