Due Diligence - Planning

P1: a/b P2: c/d QC: e/f T1: g c01 JWBT093-Gole June 2, 2009 12:34 Printer: Courier Westford PART One AL Planning RI TE MA ED HT R IG PY CO 1 P1: a/b P2: c/d QC: e/f T1: g c01 JWBT093-Gole June 2, 2009 12:34 Printer: Courier Westford 2 P1: a/b P2: c/d QC: e/f T1: g c01 JWBT093-Gole June 2, 2009 12:34 Printer: Courier Westford CHAPTER 1 Introduction OVERVIEW Mergers and Acquisitions: A Way of Corporate Life Consider the following scenario. You take an end-of-weekend look at your e-mail, only to find a message from your division’s CEO about a certain company that is in play . . . . . . The company’s founders have apparently decided that it’s time to sell their business and have retained a broker to advise them on their strategic alternatives. The broker contacted me and outlined the auction process that will be conducted. An offering memorandum will be distributed upon execution of a nondisclosure agreement. Participants will have two weeks to review the offering materials, after which nonbinding offers are expected. A selected group of bidders will be invited into the second round, which will consist of a management presentation and access to a data room, after which definitive offers are expected. We have to move quickly in order to have a chance of acquiring this property. Three activities should be initiated immediately: 1. The legal department should review and negotiate the nondis- closure agreement terms in order to receive the offering materials. 2. Business development should draft a briefing document for the corporation regarding the company: who they are, the market segment in which they operate and its attractiveness, how the 3 P1: a/b P2: c/d QC: e/f T1: g c01 JWBT093-Gole June 2, 2009 12:34 Printer: Courier Westford 4 PLANNING acquisition would help us, and how an acquisition by one of our competitors would hurt us. They should work with finance to prepare an initial valuation for sizing. We have to get the corporation up to speed and excited about this market seg- ment and the company fairly quickly because, not surprisingly, the broker has established an accelerated timetable for this deal. 3. The data room will be open in approximately three weeks. Business development, legal, and finance should assemble a due diligence team, making sure that the necessary internal experts and external advisors are lined up and ready to hit the ground running. I hope your weekend was restful—we have a lot of work ahead of us. If this scenario sounds familiar, it is because mergers and acquisitions (M&A) have become a way of corporate life. During the last five years, over 46,000 transactions were announced in the United States.1 This statistic, however, does not take into account the many prospective transactions that progress far past an initial evaluation and never come to fruition. If 46,000 transactions were completed and announced, it is probable that corporations spent significant time and resources working on several hundred thousand potential transactions over the same period. Why have there been so many acquisitions? The answer is relatively straightforward. Corporations compete to provide shareholders with a su- perior return on investment. Executives of publicly traded corporations, in particular, feel pressure to generate and sustain growth in earnings, the fac- tor upon which corporate valuations are typically based. Earnings growth is derived from three main sources: Revenue from existing and newly developed products and services Mergers and acquisitions Productivity increases and cost reduction initiatives 1 Mergerstat Review 2007 (Santa Monica, CA: Factset Mergerstat, LLC, 2007), 8. P1: a/b P2: c/d QC: e/f T1: g c01 JWBT093-Gole June 2, 2009 12:34 Printer: Courier Westford Introduction 5 While productivity and cost reduction represent important drivers of profits, in the absence of increasing revenues, these types of initiatives cannot produce sustainable, year-on-year earnings growth. As a result, revenue growth tends to dominate the agenda of corporate leaders, with internal (organic development) and external (acquisitions and alliances) growth strategies competing for priority and capital allocation. Further, as corporations grow, mature, and capture an ever-larger market share, organic growth produces diminishing returns and executives find them- selves increasingly reliant on external options such as acquisitions to boost revenue growth. Contrary to the impression fostered by the extensive media cover- age of high-profile takeovers of publicly traded companies, the majority of acquisitions occur without much fanfare. Over 95 percent of transac- tions involve “below the radar” acquisitions of privately owned compa- nies. Further, with an average transaction value of $66 million, many of these deals tend to involve comparatively small businesses, as shown in Exhibit 1.1. Indeed, many corporations view the smaller, more agile busi- nesses in their markets as incubators for new ideas that, if proven suc- cessful, can then be swept up into the acquirer’s portfolio of products and services. The good news for acquirers is that there is seemingly no shortage of such acquisition targets because small businesses represent a significant part EXHIBIT 1.1 Number and Size of Announced M&A Transactions Average Value Total Number of Percent of Nonpublic Year Transactions Nonpublic Nonpublic ($ millions) 2002 7,303 6,892 94.4% $61.4 2003 7,983 7,520 94.2% $55.8 2004 9,783 9,411 96.2% $66.8 2005 10,332 9,884 95.7% $64.6 2006 10,660 10,172 95.4% $77.6 TOTAL 46,061 43,879 95.3% $66.1 Source: Mergerstat Review, 2007. P1: a/b P2: c/d QC: e/f T1: g c01 JWBT093-Gole June 2, 2009 12:34 Printer: Courier Westford 6 PLANNING of the U.S. economy and generate a disproportionate share of its growth. More specifically, small firms: Employ about half of all private sector employees Generate about half of the gross domestic product Created 60 to 80 percent of the nation’s net new jobs2 As a result of the high volume of deals, the acquisition process has become a routine business activity within many corporations, supported by a staff of full-time business development professionals and subject to formal acquisition policies and procedures. The high level of acquisition activity has also required the regular involvement of a broad array of executives and managers from across corporate departments.