Vital steps to optimising the deal
Due diligence in the acquisition process can help buyers to mitigate risks, optimise valuations and ensure compliance. Picture: iStock
There is a natural tension to M&A transactions. On the one side, the seller wants to maximise the price they achieve for their business while on the other the buyer naturally wants to get the best value possible from the deal. But it is not a simple question of haggling over the price and splitting the difference between vendor and purchaser expectations, it’s a lot more complicated than that.
“In an environment where financing a deal is more expensive than ever, and there is wider macro-economic and geopolitical uncertainty it is increasingly challenging to deliver value from M&A,” says Ray Egan, a director with PwC Ireland Corporate Finance.
“The results of a PwC and Mergermarket study of senior global executives, found that only 61 per cent of buyers believe their last acquisition created value. However, acquirers who prioritised value creation through careful planning from the start of the deal clearly outperform industry benchmarks. Companies that establish rigorous criteria for value creation early on and who carefully plan all aspects of integration are best positioned to maximise their returns from a transaction.”
In an uncertain geopolitical and macro-economic landscape and facing high financing costs buyers are increasingly placing a greater focus on cashflows and maintainable earnings, according to EY Corporate Finance partner Ronan Murray.
“The due diligence process is a very important part of the deal to optimise the value and identify any future issues which may arise,” he notes. “As well as financial due diligence, other diligence processes including commercial, tax, IT and ESG are becoming increasingly common and of greater value to buyers to assess all aspects of both the business and the wider industry in which it operates and the position and market share of the business in the industry and growth potential. This allows the buyer to scrutinise the target’s financial records, IP, assets and liabilities, regulatory compliance and operational challenges as well as identify potential risks and market insights which can further inform whether the sellers’ target value aligns with its actual value, considering all factors.”
Thorough due diligence during the acquisition process can help buyers to mitigate risks, optimise valuations, capitalise on synergies, and ensure compliance from a governance and legal standpoint, he points out. “This enhances the overall success of all transactions in the M&A space.”
Other factors can come into play as well. “Some buyers have minimum threshold levels of return and their valuation will be struck on a basis which allows them visibility on achieving these returns,” explains Aimee Corcoran, senior manager with PwC Ireland Corporate Finance. “They will typically discount their anticipated future cash flows from the business to determine the valuation, with the discount rate used reflecting the buyer's cost of funding. Buyers will also typically have regard to market multiples as a sense check on their calculated value.”
Taking a long view is advisable when entering not a transaction. “Creating value is the ultimate goal of any M&A transaction, the reality, however, is that value creation in M&A is often a challenge, with many deals not living up to initial expectations,” says Derek Murphy, managing director, Financial Advisory with Deloitte. “This is often driven by either a lack of a comprehensive due diligence or Buyers underestimating the cost of integration, as well as accurately valuing or implementing synergies.
“From the start of the transaction, integration and synergies should be a key consideration in the due diligence phase, and buyers should seek to identify and place a value on each synergy and build this into its valuation model,” he adds. “Having a very clear picture of the risks and the opportunities of the deal and a comprehensive integration plan ensures a far greater chance of a successful acquisition in terms of return on investment and placing the business on a sound footing for growth and prosperity in the long term.”
Indeed, what happens after the deal is done is critically important for value creation. In many ways, the real work begins with the integration of the acquisition into the buyer’s existing business. “Buyers should consider integration and synergy delivery from the outset of assessing a transaction as part of their value creation plan,” says PwC Ireland Corporate Finance partner Laura Gilbride. She advises buyers to have a detailed integration and synergy plans in place at the point of signing.
“The first three to six months of the integration process are pivotal, regardless of whether it is a private equity or trade transaction,” says Murray. “Clear communication about deal rationale, growth trajectory and strategy and integration process are crucial to ensure a successful transition for the business into the next ownership stage.”
Culture is critical, according to Gilbride. “Talent management and human capital are key drivers of whether businesses deliver post-deal. The results of a PwC and Mergermarket study of senior global executives, found 82 per cent of companies who say significant value was lost in an acquisition lost more than 10 per cent of employees following the transaction. Retaining key people and getting their buy-in to the future direction of the enlarged business is critically important.”
This applies to key management in particular, says Murray. “With a private equity majority sale, the management team is very often incentivised via a share scheme or tied into an earn-out or deferred consideration mechanism. It is important that clear goals, targets and strategies are set out from the beginning as there is a shift in the dynamic due to a change of control and decision-making process with a new board in place. This can result in delays as the board and management work to align on the overall direction and strategy for the company.”
Funding the acquisition is also an important consideration. “While the cost of debt is currently going in the right direction, it is still expensive,” Murphy points out. “We often work with clients who are preparing to embark on an acquisition journey and through smart working capital optimisation, a significant level of cash can be freed up to support acquisition funding.”
On the vendor side of the equation, Ronan Murray says that favourable results tend to be achieved when sellers proactively engage in market readiness and thorough preparatory diligence. “This safeguards value, especially in a market where M&A leaders anticipate valuation becoming more stringent, tipping the scales in favour of buyers,” he says. “Engaging experienced advisors, guiding the dealmakers from the outset lead to the most successful transactions.”
Murphy also emphasises the need for early planning. “The secret to a successful sale and maximising value lies in the preparation,” he contends. “It is important for a seller to take the time to understand what is involved in a sale process and how a buyer is likely to value the business. Sellers often don’t fully appreciate the mechanics of a valuation and the fact that the initial offer from a buyer is typically adjusted to factor in cash, debt and working capital at the date of the acquisition to arrive at the equity value. Sellers should focus on implementing certain measures, at least twelve months in advance of a transaction but ideally longer, to maximise the equity value.”
Putting the best foot forward is a must. “It is really important to ensure that every aspect of the business is showcased to its maximum potential,” Egan advises. “From a financial perspective it’s about highlighting the earnings profile and cash generation of the business in the recent past and into the medium term.”
Q&A with Jim McCarthy of MC2 Accountants
It is crucial to develop a clear integration plan that outlines how the buyer will merge the operations, technologies, and cultures of the two entities to achieve efficiencies and synergies. Buyers should also strategically negotiate the purchase price and terms to ensure they align with the long-term value they anticipate from the acquisition; this may include earn-outs or deferred payments based on future performance metrics.
Valuation methods can dependin on the nature of the trading entity, current stage of the business lifecycle and the industry that it operates in. We consider the strategic value the acquisition brings, such as potential synergies, market expansion and intellectual property, which might justify a premium beyond the financials alone.
Buyers should prioritise the integration of operations, cultures and systems to maximise synergies and efficiencies between the merging entities. Communicate transparently with all stakeholders, employees, customers and suppliers. Review the combined entity's strategic objectives and performance metrics to align them with the new business goals.
Sellers should thoroughly prepare their financial and operations info for due diligence. This involves ensuring all financial statements are accurate, complete and that the information is current, which helps to build credibility and trust with potential buyers. Enhancing the business's value can also be achieved by identifying and cultivating key growth opportunities, demonstrating clear and sustainable future revenue streams. Additionally, engaging professional advisors like MC2 to market the business to a wide range of suitable buyers can assist with the overall process, potentially leading to a higher sale price.
