Reading: The Takeover Process

1) The Business Plan

It is important to understand that M&A or corporate restructuring per se is not a business strategy. It can be a tool to implement a (well-considered) business strategy. 

Therefore, before engaging in M&A, it is indispensable to understand the firm's strategy and how the combined entities can make that strategy more valuable. To do so, it is helpful to (re)consider the firm's

• Long-term goals (mission, vision)
• Market
• Current strengths, weaknesses, opportunities, and threats (SWOT)
• Key strategic objectives
• Financial situation and valuation
• Risks.

All this information is summarized in the firm's business plan.

   

2) The Acquisition Plan

To implement the business plan (strategy), it might be necessary to engage in M&A. The various reasons why such M&A transactions can be helpful have been discussed in the Introduction. In particular, M&A could help to:

• Exploit an opportunity (e.g., apply an existing technology to new markets)
• Avert a threat (e.g., intellectual property litigation as in the case of Motorola Mobile)
• Achieve financial goals (e.g., cost leadership through capacity-reducing mergers)

 

If this is the case, the logical next step is to compose an acquisition plan, which focuses on the tactical and more short-term oriented issues surrounding the implementation of the deal. This internal document answers the why, when, who, how, and how much for the planned transaction. It is a dynamic document which evolves as the firm learns about potential targets and their bargaining position. An acquisition plan typically addresses the following issues:

 

• Objectives: What is the purpose of the planned acquisition (e.g., access to patents)?
   
• Timetable: Define milestones (e.g., closure, integration) and by when these milestones should be reached.
   
• Resources and capabilities: Set the budget for the transaction (e.g., 350 million), identify the responsible managers or teams, and define how much management time can be dedicated to the transaction.
   
• Deal type: Defined the preferred method of acquisition (e.g., full control vs. partial ownership; friendly deal vs. hostile deal, etc.).
   
• Search plan: Define how potential targets can be identified, how the actual target company will be chosen, and how that company will then be approached.
   
• Negotiation strategy: Think about how to structure the deal, how potential valuation gaps could be bridged, and what the main negotiation issues might be (form of merger, type of payment, future management involvement, tax structure, etc.).
   
• Initial offer price: Set the initial offer price. To do so,
  • Conduct a valuation of the target and the acquirer (stand-alone as well as integrated) and estimate synergies and integration costs.
  • Compile a list with the key assumptions and the preliminary offer price range for the target that results based on these assumptions.
  • Finally, set the initial offer price as well as its composition (cash, stock, etc.)
     
• Financing plan: Determine how the offer price can be financed (excess cash, borrowing, issuance of new shares) and how the transaction affects key financials (in particular earnings per share, EPS).
   
• Integration plan: Identify the key integration challenges (e.g., IT integration, corporate culture) and how these challenges can be resolved.

   

3) The Search Process

The next step is to structure the search process. How to actually identify potential target companies? Especially in the context of geographic expansions or expansions into new fields, the acquiring firm's management team might not be fully aware of who the potentially attractive firms could be. The search process typically involves a two-step procedure:

• Define the screening / selection criteria (i.e., which filters will be applied). Frequently used filters are:
  • Geography (Country, Region, Area)
  • Industry
  • Brands
  • Company size
  • Company ownership
  • Business model
    
    
• Develop a search strategy. Lists of "available" firms cannot be simply downloaded from the internet. Typical search strategies could be:
  • Hire consultants or investment bankers (for larger projects)
  • Talk to commercial banks or accounting firms
  • Place ads online or in local newspapers
  • Consult yellow pages or other business networks
  • Use google maps 
  • Delegate assistants to screen the neighborhoods

 

This search process should yield a relatively extensive list of potential target companies.

  

4) The Screening Process

The next step is to shorten that list by applying secondary criteria such as:

• Market segments and product lines
• Market share
• Profitability, financial stability
• Cultural compatibility

 

This screening process should allow the firm to identify the most attractive target companies. Whenever possible, that list should contain more than one company, as it is generally very difficult to negotiate if one has only one alternative. Depending on the specific situation, the result of the screening process can be a ranking of potential targets from 1 to N.

 

5) The First Contact

Until now, the target company was most likely unaware of the fact that another entity is interested in an acquisition. The first contact with the target company is crucial. It often sets the tone for the whole negotiation and plays and is an important determinant of whether a transaction will take place successfully.

How exactly this first contact is established depends on various factors, including:

• Size of the company
• Management style
• Market environment
• Stakeholder structure
• Purpose of the acquisition
• Timeline

 

Equally importantly, one has to decide who to address, and how. Who to address?

• In principle, one should talk to the highest level possible.
• In small firms, this is often the founder or her family.
• In medium-sized or larger companies, it could be the CEO, a member of the board, or a larger shareholder.

 

How to address the target?

• It is important to strike the right chord.
• Often, it is helpful to use intermediaries (counsels, bankers, accountants, mutual stakeholders).
• Discretion is extremely important. Without discretion, it is difficult or impossible to build trust. Moreover, leaking information could trigger fierce reactions.
• In many cases, it is also not helpful to discuss the valuation right away. It is generally better to talk about the general business environment and the key value drivers of the business that will, ultimately, determine the valuation.

   

This stage of the process cannot be rushed. It is important to take the time to develop a personal relationship with the seller and to build an atmosphere of mutual trust and understanding. In such an environment, it is generally easier and quicker to negotiate, and it is much simpler to integrate the companies after the deal. Transactions that take place in a hostile environment are rarely successful.

  

Around the first contact, it will also be important to prepare several preliminary legal documents, in particular confidentiality agreements, a term sheet, and a letter of intent.

• Confidentiality (nondisclosure agreement)
  • A takeover process is very information intensive
  • The shared data (historical financials, product pipeline, customer list, etc.) is highly confidential
  • Confidentiality agreements are generally mutually binding and cover all non-public data
  • The exchange of data is crucial, as this is often the only way to learn about how much value a deal can potentially create (e.g., it is important to know whether the client base is strongly overlapping, etc.)

 

• Term sheet
• A 2-4 pages long document that outlines the primary terms with the seller
• The document indicates a price range for the target, identifies what exactly is being acquired, and how the acquisition will take place.
• The document also defines the behavior of the parties during the negotiation process. For example, whether an offer can be presented to other potential buyers (shop or no-shop provisions) or whether the target is allowed to solicit other bids (exclusivity).
• The term sheet is a document that evolves as the negotiations evolve.

 

• Letter of intent (LOI): Finally, the letter of intent is the (dynamic) governing document for the deal, as it summarizes the reasons for the agreement and the major deal terms and conditions:
  • Structure
  • Price range
  • Payment method
  • Validity of offer
  • Due diligence
  • Access to plants and premises
  • Communication of the transaction
  • Etc.