Chapter 6 - Sell-Side M&A
Overview
Sale of a company, division, business, or collection of assets (“target”) is a major event for its owners (shareholders), management, employees, and other stakeholders
Seller typically hires an investment bank and its team of trained professionals (“sell-side advisor”) to ensure that key objectives are met and a favorable result is achieved
Sell-side advisor seeks to achieve the optimal mix of value maximization, speed of execution, and certainty of completion among other deal-specific considerations for the selling party
From an analytical perspective, a sell-side assignment requires the deal team to perform a comprehensive valuation of the target using those methodologies discussed in previous chapters
For public targets (and certain private targets, depending on the situation) the sell-side advisor or an additional investment bank may be called upon to provide a fairness opinion
Auctions
An auction is a staged process whereby a target is marketed to multiple prospective buyers (“buyers” or “bidders”)
Provides a level of comfort that the market has been tested as well as a strong indicator of inherent value (supported by a fairness opinion, if required)
May have potential drawbacks:
Information leakage into the market from bidders
Negative impact on employee morale
Possible collusion among bidders
Reduced negotiating leverage once a “winner” is chosen (thereby encouraging re-trading)
“Taint” in the event of a failed auction
Successful auction requires significant dedicated resources, experience, and expertise
Investment banks commit a team of bankers that is responsible for the day-to-day execution of the transaction
Also require significant time and attention from key members of the target’s management team
In the later stages of an auction, a senior member of the sell-side advisory team typically negotiates directly with prospective buyers with the goal of encouraging them to put forth their best offer
Two types of auctions ― Broad Auction and Targeted Auction.
Broad auction
Maximizes the universe of prospective buyers approached. This involves contacting dozens of potential bidders, comprising both strategic buyers (potentially including direct competitors) and financial sponsors
By casting as wide a net as possible, a broad auction is designed to maximize competitive dynamics, thereby increasing the likelihood of finding the best possible offer
Typically involves more upfront organization and marketing due to the larger number of buyer participants in the early stages of the process
Targeted auction
Focuses on a few clearly defined buyers that have been identified as having a strong strategic fit and/or desire, as well as the financial capacity, to purchase the target
More conducive to maintaining confidentiality and minimizing business disruption to the target
Greater risk of “leaving money on the table” by excluding a potential bidder that may be willing to pay a higher price
Auction structure
Traditional auction is structured as a two-round bidding process that generally spans from three to six months (or longer) from the decision to sell until the signing of a definitive purchase/sale agreement (“definitive agreement”) with the winning bidder
Timing of the post signing (“closing”) period depends on a variety of factors not specific to an auction, such as regulatory approvals and/or third-party consents, financing, and shareholder approval
Entire auction pror45cess consists of multiple stages and discrete milestones within each of these stages
Organization and Preparation
Organization and preparation
Identify Seller Objectives and Determine Appropriate Sale Process
Perform Sell-Side Advisor Due Diligence and Preliminary Valuation Analysis
Select Buyer Universe
Prepare Marketing Materials
Prepare Confidentiality Agreement
Prepare marketing materials
Intro
The teaser is the first marketing document presented to prospective buyers
Designed to inform buyers and generate sufficient interest for them to do further work and potentially submit a bid
Generally a brief one- or two-page synopsis of the target, including a company overview, investment highlights, and summary financial information
Confidential information memorandum
The CIM is a detailed written description of the target (often 50+ pages) that serves as the primary marketing document for the target in an auction
The deal team, in collaboration with the target’s management, spends significant time and resources drafting the CIM before it is deemed ready for distribution to prospective buyers
Like teasers, CIMs vary in terms of format and content depending on situation-specific circumstances
Financial Information
CIM contains a detailed financial section presenting historical and projected financial information with accompanying narrative explaining both past and expected future performance (MD&A)
Involves normalizing the historical financials (e.g., for acquisitions, divestitures, and other one-time and/or extraordinary items) and crafting an accompanying MD&A
In some cases, the CIM provides additional financial information to help guide buyers toward potential growth/acquisition scenarios for the target
Prepare Confidentiality
A confidentiality agreement (CA) is a legally binding contract between the target and each prospective buyer that governs the sharing of confidential company information
Drafted by the target’s counsel and distributed to prospective buyers along with the teaser, with the understanding that the receipt of more detailed information is conditioned on execution of the CA
Typical CA includes provisions governing the following:
Use of information
Term
Permitted disclosures
Return of confidential information
Non-solicitation/no hire
Standstill agreement
Restrictions on clubbing
First Round
Contact Prospective Buyers
Negotiate and Execute Confidentiality Agreements with Interested Parties
Distribute Confidential Information Memorandum and Initial Bid Procedures Letter
Prepare Management Presentation
Set up Data Room
Prepare Stapled Financing Package (if applicable)
Receive Initial Bids and Select Buyers to Proceed to Second Round
Contact Prospective Buyers
The first round begins with the contacting of prospective buyers, which marks the formal launch of the auction process
Typically takes the form of a scripted phone call to each prospective buyer by a senior member of the sell-side advisory team (and/or the coverage banker that maintains the relationship with the particular buyer), followed by the delivery of the teaser and CA
Sell-side advisor generally keeps a detailed record of all interactions with prospective buyers, called a contact log, which is used as a tool to monitor a buyer’s activity level and provide a record of the process
Negotiate and Execute Confidentiality Agreements with Interested Parties
Upon receipt of the CA, a prospective buyer presents the document to its legal counsel for review
In the likely event there are comments, the buyer’s counsel and seller’s counsel negotiate the CA with input from their respective clients
Following execution of the CA, the sell-side advisor is legally able to distribute the CIM and initial bid procedures letter to a prospective buyer
Typical CA includes provisions governing the following:
Use of information: states that all information furnished by the seller, whether oral or written, is considered proprietary information and should be treated as confidential and used solely to make a decision regarding the proposed transaction
Term: designates the time period during which the confidentiality restrictions remain in effect
Permitted disclosures: outlines under what limited circumstances the prospective buyer is permitted to disclose the confidential information provided; also prohibits disclosure that the two parties are in negotiations
Return of confidential information: mandates return or destruction of all provided documents once prospective buyer exits process
Non-solicitation/no hire: prevents prospective buyers from soliciting to hire (or hiring) target employees for designated time period
Standstill agreement: for public targets, precludes prospective buyers from making unsolicited offers or purchases of the target’s shares, or seeking to control/influence the target’s management, board of directors, or policies
Restrictions on clubbing: prevents prospective buyers from collaborating with each other or with outside financial sponsors/equity providers without the prior consent of the target (in order to preserve a competitive environment)
Distribute Confidential Information Memorandum and Initial Bid Procedures Letter
Prospective buyers are typically given several weeks to review the CIM, study the target and its sector, and conduct preliminary financial analysis prior to submitting their initial non-binding bids
Depending on their level of interest, prospective buyers may also engage investment banks (as M&A buy-side advisors and/or financing providers), other external financing sources, and consultants at this stage
Buy-side advisors play a critical role in helping their client, whether a strategic buyer or a financial sponsor, assess the target from a valuation perspective and determine a competitive initial bid price
Financing sources help assess both the buyer’s and target’s ability to support a given capital structure and provide their clients with data points on amounts, terms, and availability of financing
Initial Bid Procedures Letter
Initial bid procedures letter states the date and time by which interested parties must submit their written, non-binding preliminary indications of interest (“first round bids”)
Also defines the exact information that should be included in the bid, such as
Indicative purchase price (typically presented as a range) and form of consideration (cash vs. stock mix)
Key assumptions to arrive at the stated purchase price
Structural and other considerations
Information on financing sources
Treatment of management and employees
Timing for completing a deal and diligence that must be performed
Key conditions to signing and closing
Required approvals
Buyer contact information
Prepare Management Presentation
The management presentation is typically structured as a slideshow with accompanying hardcopy handout
Sell-side advisor takes the lead on preparing these materials with substantial input from management
The presentation format generally maps to that of the CIM, but is more crisp and concise
Set up Data Room
The data room serves as the hub for the buyer due diligence that takes place in the second round of the process
It is a location, typically online, where comprehensive, detailed information about the target is stored, catalogued, and made available to pre-screened bidders
Data rooms generally contain a broad base of essential company information, documentation, and analyses
Also contains detailed company-specific information such as customer and supplier lists, labor contracts, purchase contracts, description and terms of outstanding debt, lease and pension contracts, and environmental compliance certification
The data room also allows the buyer (together with its legal counsel, accountants, and other advisors) to perform more detailed confirmatory due diligence prior to consummating a transaction
Sell-side bankers work closely with the target’s legal counsel and selected employees to organize, populate, and manage the data room
Access to the data room is typically granted to those buyers that move forward after first round bids, prior to, or coinciding with, their attendance at the management presentation
Prepare Stapled Financing Package (if applicable)
The investment bank running the auction process (or sometimes a “partner” bank) may prepare a “pre-packaged” financing structure in support of the target being sold
For public companies, legal advisors need to be consulted before a sell-side advisor can be approved to provide a stapled financing
Often, buyers seek their own financing sources to match or “beat” the staple
To avoid a potential conflict of interest, the investment bank running the M&A sell-side sets up a separate financing team distinct from the sell-side advisory team to run the staple process
The basic terms of the staple are typically communicated verbally to buyers in advance of the first round bid date so they can use that information to help frame their bids
While buyers are not obligated to use the staple, it is designed to send a strong signal of support from the sell-side bank and provide comfort that the necessary financing will be available to buyers for the acquisition
The staple may also compress the timing between the start of the auction’s second round and signing of a definitive agreement by eliminating duplicate buyer financing due diligence
Receive Initial Bids and Select Buyers to Proceed to Second Round
On the first round bid date, the sell-side advisor receives the initial indications of interest from prospective buyers
An effective sell-side advisor is able to discern which bids are “real” (i.e., less likely to be re-traded)
May also be dialogue with certain buyers at this point, typically focused on seeking clarification on key bid points
Final decision regarding which buyers should advance, however, is made by the seller in consultation with its advisors
Second Round
Second round of the auction centers on facilitating the prospective buyers’ ability to conduct detailed due diligence and analysis so they can submit strong, final (and ideally) binding bids by the set due date
The diligence process is meant to be exhaustive, typically spanning several weeks, depending on the target’s size, sector, geographies, and ownership
Length and nature of the diligence process often differs based on the buyer’s profile
Sell-side advisor plays a central role during the second round by coordinating management presentations and facility site visits, monitoring the data room, and maintaining regular dialogue with prospective buyers
Prospective buyers are given sufficient time to complete their due diligence, secure financing, craft a final bid price and structure, and submit a markup of the draft definitive agreement
The sell-side advisor seeks to maintain a competitive atmosphere and keep the process moving by limiting the time available for due diligence, access to management, and ensuring bidders move in accordance with the established schedule
Conduct Management Presentations
The management presentation typically marks the formal kickoff of the second round, often spanning a full business day
At the presentation, the target’s management team presents each prospective buyer with a detailed overview of the company
Core team presenting typically consists of the target’s CEO, CFO, and key division heads or other operational executives, as appropriate
Customary for prospective buyers to bring their investment banking advisors and financing sources, as well as industry and/or operational consultants, to the management presentation
The management presentation is often the buyer’s first meeting with management
Facilitate Site Visits
Site visits are an essential component of buyer due diligence, providing a firsthand view of the target’s operations
Often, the management presentation itself takes place at, or near, a key company facility and includes a site visit as part of the agenda
The typical site visit involves a guided tour of a key target facility, such as a manufacturing plant, distribution center, and/or sales office
Provide Data Room Access
The data room contains detailed information about all aspects of the target (e.g., business, financial, accounting, tax, legal, insurance, environmental, information technology, and property)
Through rigorous data analysis and interpretation, the buyer seeks to identify the key opportunities and risks presented by the target, thereby framing the acquisition rationale and investment thesis
Process also enables the buyer to identify those outstanding items and issues that should be satisfied prior to submitting a formal bid and/or specifically relating to the seller’s proposed definitive agreement
Data room access may be tailored to individual bidders or even specific members of the bidder teams (e.g., limited to legal counsel only)
Distribute Final Bid Procedures Letter and Draft Definitive Agreement
During the second round, the final bid procedures letter is distributed to the remaining prospective buyers often along with the draft definitive agreement
As part of their final bid package, prospective buyers submit a markup of the draft definitive agreement together with a cover letter detailing their proposal in response to the items outlined in the final bid procedures letter
Final Bid Procedures Letter (1)
The final bid procedures letter outlines the exact date and guidelines for submitting a final, legally binding bid package
Requirements for the final bid are stringent:
Purchase price details, including the exact dollar amount of the offer and form of purchase consideration (e.g., cash versus stock)
Markup of the draft definitive agreement provided by the seller in a form that the buyer would be willing to sign
Evidence of committed financing and information on financing sources
Attestation to completion of due diligence (or very limited confirmatory due diligence required)
Attestation that the offer is binding and will remain open for a designated period of time
Required regulatory approvals and timeline for completion
Board of directors approvals (if appropriate)
Estimated time to sign and close the transaction
Buyer contact information
Definitive Agreement (2)
The definitive agreement is a legally binding contract between buyer and seller detailing the terms and conditions of the sale transaction
Distributed to prospective buyers (and their legal counsel) during the second round—often toward the end of the diligence process
Ideally, the buyer is required to submit a form of revised definitive agreement that it would be willing to sign immediately if the bid is accepted
Definitive agreements involving public and private companies differ in terms of content, although the basic format of the document is the same
Overview of the transaction structure/deal mechanics
Representations and warranties
Pre-closing commitments (including covenants)
Closing conditions
Termination provisions
Indemnities (if applicable)
Associated disclosure schedules and exhibits
Receive Final Bids
Upon conclusion of the second round, prospective buyers submit their final bid packages to the sell-side advisor by the date indicated in the final bid procedures letter
These bids are expected to be final with minimal conditionality, or “outs,” such as the need for additional due diligence or firming up of financing commitments
In practice, the sell-side advisor works with viable buyers throughout the second round to firm up their bids as much as possible before submission
Negotiations
Evaluate Final Bids
The sell-side advisor works together with the seller and its legal counsel to conduct a thorough analysis of the price, structure, and conditionality of the final bids
Purchase price is assessed within the context of the first round bids and the target’s recent financial performance, as well as the valuation work performed by the sell-side advisors
The deemed binding nature of each final bid, or lack thereof, is also
Negotiate with Preferred Buyers
Often, the sell-side advisor recommends that the seller negotiates with two (or more) parties, especially if the bid packages are relatively close
Advisor seeks to maintain a level playing field so as not to advantage one bidder over another and maximize the competitiveness of the final stage of the process
During these final negotiations, the advisor works intensely with the bidders to clear away any remaining confirmatory diligence items (if any)
Select Winning Bidder
The sell-side advisor and legal counsel negotiate a final definitive agreement with the winning bidder, which is then presented to the target’s board of directors for approval
Seller normally reserves the right to reject any and all bids as inadequate at every stage of the process
Each prospective buyer has the right to withdraw from the process at any time prior to the execution of a binding definitive agreement
Not all auctions result in a successful sale
Render Fairness Opinion
In response to a proposed offer for a public company, the target’s board of directors typically requires a fairness opinion to be rendered as one item for their consideration before making a recommendation on whether to accept the offer and approve the execution of a definitive agreement
A fairness opinion is a letter opening on the “fairness” (from a financial point of view) of the consideration offered in a transaction
Opinion letter is supported by detailed analysis and documentation providing an overview of the sale process run (including number of parties contacted and range of bids received), as well as an objective valuation of the target
Prior to the delivery of the fairness opinion to the board of directors, the sell-side advisory team must receive approval from its internal fairness opinion committee
In a public deal, the fairness opinion and supporting analysis is publicly disclosed and described in detail in the relevant SEC filings
Receive Board Approval and Execute Definitive Agreement
Once the seller’s board of directors votes to approve the deal, the definitive agreement is executed by the buyer and seller
A formal transaction announcement agreed to by both parties is made with key deal terms disclosed depending on the situation
The two parties then proceed to satisfy all of the closing conditions to the deal, including regulatory and shareholder approvals
Closing
Obtaining Necessary Approvals
Regulatory Approval
The primary regulatory approval requirement for the majority of U.S. M&A transactions is made in accordance with the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the “HSR Act”)
Depending on the size of the transaction, the HSR Act requires both parties to an M&A transaction to file respective notifications and report forms with the Federal Trade Commission (FTC) and Antitrust Division of the Department of Justice (DOJ)
Companies with significant foreign operations may require approval from comparable foreign regulatory authorities such as the Competition Bureau (Canada) and European Commission (European Union)
The HSR filing is typically made directly following the execution of a definitive agreement
Shareholder Approval: One-Step Merger
In a “one-step” merger transaction for public companies, target shareholders vote on whether to approve or reject the proposed transaction at a formal shareholder meeting pursuant to relevant state law
Shareholder approval is typically determined by a majority vote, or 50.1% of the voting stock
In a one-step merger, the timing from the signing of a definitive agreement to closing may take as little as six weeks, but often takes longer (perhaps three or four months) depending on the size and complexity of the transaction
Main driver of the timing is the SEC’s decision on whether to comment on the public disclosure documents
Following the SEC’s approval, the documents are mailed to shareholders and a meeting is scheduled to approve the deal, which typically adds a month or more to the timetable
Shareholder Approval: Two-Step Tender Process
Alternatively, a public acquisition can be structured as a “two-step” tender offer on either a negotiated or unsolicited basis, followed by a merger
In Step I of the two-step process, the tender offer is made directly to the target’s public shareholders with the target’s approval pursuant to a definitive agreement
The tender offer is conditioned, among other things, on sufficient acceptances to ensure that the buyer will acquire a majority (or supermajority, as appropriate) of the target’s shares within 20 business days of launching the offer
If the buyer only succeeds in acquiring a majority (or supermajority, as appropriate) of the shares in the tender offer, it would then have to complete the shareholder meeting and approval mechanics in accordance with a “one-step” merger (with approval assured because of the buyer’s majority ownership)
If the requisite threshold of tendered shares is reached as designed (typically 90%), the acquirer can subsequently consummate a back-end “short form” merger (Step II) to squeeze out the remaining public shareholders without needing to obtain shareholder approval
In a squeeze out scenario, entire process can be completed much quicker than a one-step merger; few as five weeks
If the buyer needs to access the public capital markets to finance the transaction, the timing advantage of a tender offer would most likely be lost as such transactions typically take approximately 75 to 90 days to arrange post-signing
Financing and Closing
In parallel with obtaining all necessary approvals and consents as defined in the definitive agreement, the buyer proceeds to source the necessary capital to fund and close the transaction
Financing process timing may range from relatively instantaneous (e.g., the buyer has necessary cash-on-hand or revolver availability) to several weeks or months for funding that requires access to the capital markets (e.g., bank, bond, and/or equity financing)
In the latter scenario, the buyer begins the marketing process for the financing following the signing of the definitive agreement so as to be ready to fund expeditiously once all of the conditions to closing in the definitive agreement are satisfied
Acquirer may also use bridge financing to fund and close the transaction prior to raising permanent debt or equity capital
Once the financing is received and conditions to closing in the definitive agreement are met, the transaction is funded and closed
Negotiated Sale
While auctions were prevalent as a sell-side mechanism during the LBO boom of the mid-2000s, a substantial portion of M&A activity is conducted through negotiated transactions
In contrast to an auction, a negotiated sale centers on a direct dialogue with a single prospective buyer
Negotiated sales are particularly compelling in situations involving a natural strategic buyer with clear synergies and strategic fit
In many negotiated sales, the banker plays a critical role as the idea generator and/or intermediary before a formal process begins
Many of the key negotiated sale process points mirror those of an auction, but on a compressed timetable
In some cases, a negotiated sale may move faster than an auction as much of the upfront preparation, buyer contact, and marketing is bypassed
Ideally the seller realizes fair and potentially full value for the target while avoiding the potential risks and disadvantages of an auction