In my 20-plus years in the M&A business I’ve learned three truths of the trade: A business is always for sale. A business is not always prepared to be sold. And culture, strategy and price matter most in an acquisition. What’s your culture? It’s everything from whether you have high variable pay vs. high base pay to whether you compensate certain roles substantially more to whether the business is run with the expectation of generating higher or lower profits. It’s difficult to integrate culturally divergent businesses.
The CFO role is incredibly more complicated than it was 20 years ago. You have to deal with extreme stock market volatility, trade wars, inverted yield curves and vendor consolidation, not to mention technologies, like blockchain and AI, that have game-changing potential. Fast-growing companies are increasingly being approached by private equity (PE) firms, bankers and strategic buyers, including competitors.
Unless you’re prepared to respond proactively, evaluating serious preemptive offers is going to be disruptive — sometimes enough to destroy business momentum and even harm long-term shareholder value.
We once advised a hot, international SaaS firm in a specialized, valuable vertical that was starting to go up against large, public international competitors. This firm had great IP, but going head-to-head was like taking a knife to a gun fight. The firm believed that if it aligned with someone larger, it could take money concerns off the table, be more competitive and provide a better future for its workers because it’d be more financially stable and have a stronger competitive offering.
Alignment with a larger enterprise would be a win, win, win, and the market recognized this. The executive team was getting opportunistically approached by buyers and accepted discussions in a generally undisciplined way with anyone who met the minimum mandate.
Because the firm’s value was based on revenue growth and gross margin, not overall earnings, anytime the company took its foot off the growth gas pedal, it was a problem.
As they started taking more calls, the team began interviewing investment bankers and identified us as a likely advisor. As we were sending the final draft of our engagement agreement, they informed us that they’d agreed to a 60-day no-shop contract with a PE group that knew very little about the firm’s SaaS business.
Maybe you can guess what happened. The CEO and CFO of a very lean management team spent more than 60 days educating and qualifying the PE, then lost focus. The deal went nowhere. It was an expensive boondoggle.
This is the dilemma CFOs frequently face: How do you determine what information is appropriate to share, and when, with a potential buyer? How do you identify more-specific data they’ll need? Furthermore, how do you share business strategy and go-to-market data with a prospect that doesn’t really know much about your business — or with a strategic competitor?
If you haven’t been approached, there’s a good chance you will be. One PE buyer we know submitted 1,000 Indications of Interest (IOIs), 100 Letters of Intent (LOIs) — and acquired only one company.
I don’t mean to suggest that entertaining an unsolicited offer can’t be a worthwhile endeavor. The key is having processes in place for various types of inquiries so that reacting is as seamless and minimally disruptive as possible. You never know, the result might be a good outcome for your business.
One note: As CFO, you must get comfortable with the fact that you may never know exactly what the business is worth at any given time. You may receive an unbelievably attractive offer and not realize it. Alternatively, you could accept an offer that’s not what it should be because you don’t know any differently. But you absolutely can be more prepared than other potential acquisition targets a PE or strategic might be looking at. At the very least, this exercise will give you a ballpark idea of market worth so you’re less likely to miss a solid offer or end up under-valued.
So how do you prep your business for sale when it’s not for sale?
There are five steps every CFO should take. This isn’t a set-it-and-forget-it exercise. Your plan needs to be updated periodically, as makes sense for your company.
1. First, identify public companies that look like yours. Build a model that compares gross margin, earnings, growth rate, SG&A as a percentage of gross margin, size, and that tracks your comparative revenue and EBITDA multiples. Remember: Apply an appropriate premium because these companies are public, larger, have audited financials and other factors. Additionally, they warrant a liquidity premium because they can offer shares on the open market and don’t have to sell the company to access cash. Of course, when you’re selling a smaller company, you’re selling control, not minority shares that trade on the exchanges. That’s advantageous and warrants its own premium. A good rule of thumb is to discount 25% to public comparables.
2. The next step is to identify all the transactions that happened in your space over the past 12 to 24 months and maintain a disciplined practice to track revenue and EBITDA multiples that are ascertainable. In some cases, the financial information you’re concerned about won’t be disclosed, for a number of reasons. Maybe the acquirer is so large the purchase price is de minimus, therefore it doesn’t have to be disclosed. If it’s a private-to-private transaction, particularly with PE buyers, same thing. You need to find sources that can provide that information. Investment banks that specialize in a discrete vertical frequently publish that material for free. Our scoreboard provides median multiples in the IT sector, and our tracker tracks transactions under IT services, supply chain, software and SaaS.
3. The third step is to figure out the ownership/shareholders/executive management prerogative, or the qualitative factors. Do they want to stay long-term? Short-term? Is there a succession plan in place if it’s a sole proprietorship or if the owner is older? How long do I as CFO want to stay after a sale? Figure out what qualitative items the executive team wants from a combination or transaction, independent of the purchase price.
Don’t be too inflexible here. We once sold a company with three principal shareholders. One wanted to stay for three years, but the buyer didn’t want him. One wanted to stay for one year, and the buyer wanted him for three. One wanted to stay for one year, the other two paid him to stay for three, and he ended up staying for 10. Point is, nothing is set in stone if the offer is good enough.
4. After the team figures out its qualitative needs for an acquisition, determine the quantitative component. This is critically important in determining the form and mix of the consideration. Am I a cash-only seller? Am I prepared to take an earn-out or contingent payments, and for how long? What’s our near-term visibility and confidence in the data that will impact that decision? Is it a transaction that will involve roll-over equity? Would we take roll-over equity in a private company versus a public company? Control or minority stake?
It’s imperative to sit down, formalize and articulate both the qualitative and quantitative factors that will impact an acquisition. The process becomes straightforward after you nail down these factors — just like going to an auction, where there’s a catalogue that provides a price range that an item is expected to sell for. You then decide what you’re willing to pay. Once it hits your number, you stop raising your hand. Same deal once the management team has that clarity.
5. For unsolicited inquiries, the CFO does most of the work. But they shouldn’t. The fifth and final step that CFOs must take during a preemptive acquisition process is arguably the most important: Understand that it’s the buyer who must do the work. Don’t sign an NDA and say, “Come on in!” Make them work for it, and I don’t mean just coming up to speed on your vertical. They need to demonstrate a burning commitment and establish making a deal as a real priority. They need to engage, solicit, be transparent and sensitive, and they can’t cross any red lines, not one time.
There’s a cadence to data sharing. No acquirer, whether a PE or strategic competitor, gets everything upfront. It talks with your customers only at the very end of negotiations, and you tightly manage that process. Compensation and customer data flows only after the buyer is fully qualified, has drafted a purchase agreement, you’ve gone back and forth on terms, and you see visibility to closing. The process is even more restrictive with a strategic.
In my experience, when a qualified suitor has to do real work and the fit is right, they’ll convert to a serious buyer. Meanwhile, your business isn’t disrupted, you didn’t waste time, you aren’t worried about locking down your employees or having information leaked. It’s all controlled in the process.
Marty Wolf has been involved in more than 150 IT M&A transactions during the last 20 years, creating over $5 billion in value. In addition to his responsibilities as president of global M&A advisory firm martinwolf M&A Advisors, which he founded in 1997, he actively manages transactions, has been directly involved in the divestiture of seven Fortune 500 divisions, and closed transactions in over 22 countries in segments including IT services, supply chain, and SaaS. Marty also acts as counselor and trusted adviser to CEOs of select IT firms. He has advised on take-private strategies and corporate carve-outs, as well as defended firms in hostile tender offers. He is a columnist and frequent speaker at IT and M&A conferences. Contact Marty via email.