Feeling uncertain about all the acronyms and types of M&A deals everyone’s talking about? Have no fear! We’re here to lay it all out for you in a simple–and hopefully fun–way so that you can make strategic decisions confidently! Here are all things M&A!
M&A is an umbrella term that covers several different styles of major business transactions, where one or more businesses are being sold or transferred. The most common types of Mergers and Acquisitions are:
There are several different ways to structure all of these deals, but those are the most common.
To keep this simple, we’ll be talking about Companies S (for Seller) and B (for Buyer).
Mergers have the following most common types:
The above examples almost always have different numbers in practice. I just used 50% each time since it’s simple, but it’s rare that 2 businesses are exactly the same size or have the same valuation.
Purchases of the entire business or all of the business’s assets are probably the most common of M&A transactions that take place, and usually what people mean when they say M&A work.
There are 2 major types of acquisitions:
Usually, a seller will put their company “on the market,” listing it with a broker or on an exchange site that lists out businesses for sale. The buyer will find the business through marketing efforts of the broker or from the website where it’s listed for purchase. After some basic correspondence, the buyer would normally hire a law firm to write an “LOI,” which stands for Letter of Intent. This is a key step–the fundamental deal breaker terms MUST be included in the LOI, since it’s hard to create those provisions when negotiating the final purchase contract (this is a common spot where the buyers can mess up). Once the LOI is signed by both Buyer and Seller, we start the Due Diligence phase, where the buyer hires various professionals to review the seller’s company books, assets, accounting documents, debt, etc., and if it’s a larger transaction, they normally run background checks against the company and principal owners. Once that’s done, the parties move into drafting the final purchase agreement. Normally, the buyer’s attorney drafts the first version, it gets redlined (edited) by the seller’s attorney, and once wecomplete negotiations, we get to the closing. Normally, Closings are done digitally for modern purchase agreements. Then the funds are paid from the buyer to the seller, and everyone goes their merry way.
To buy and run a business successfully, you need a good reason; you need a plan. Are you going to grow the business through your own unique contacts or experience as an optimizer? Do you plan to retire from this business and use it more like an asset that pays for your retirement with minimal maintenance requirements from you? Are you buying this business as an investment strategy with other investors or partners? What industry do you want to go into, what market? When do you want to get into that market/industry? If you don’t have a plan, you plan to fail–choose wisely!
There will be a lot of opinionated parties when it comes to the valuation of a business, and everyone has slightly different incentives for how to value it and structure the purchase agreement. The seller usually wants the highest valuation possible with the lowest amount of seller financing (where the seller gives the buyer a loan for the percentage of the purchase price that they can’t yet afford to pay). The seller’s broker probably gets paid a commission, but the commission they receive may or may not include the earn-out that the seller could make as an employee of the business post-sale–meaning that the broker might be ok with a lower overall sales price with no earnout rather than a higher sales price if the earnout is included (because the broker doesn’t benefit from the earnout money). The buyer normally wants a low price, but it’s often worth it to put in “holdbacks” that allow the buyer to pay less for the business if the business does not perform as well as the buyer expects it to (minimum revenue for the 1-3 years post closing, for example).
There are also several professional appraisers who will have their opinions on the valuation of the company. Normally, the buyer will get some bank financing to purchase the business, and if they do, the bank will have to appraise the company so that the purchase price matches the appraised value. Similarly, buyers and sellers will often hire independent valuation specialists to do their own appraisals of a company’s value.
If it’s a merger, then the value of the two companies needs to be factored into the equation so that the buyer with the more valuable company ends up with a higher percentage of the resulting merged entity than the other party.
Similar to buying a house, this phase usually comes after the LOI is signed and before the final purchase agreement is drafted. The buyer has a set amount of time to review the business and sort of “kick the tires” to see if, in fact, it looks to be what the seller claims it to be–that it’s worth what the LOI said it would cost.
Due diligence almost always includes an inspection of the company’s books, such as their profits and loss reports (P&Ls), their Balance Sheets, often a review of the company’s tax returns for 3 years running, and sometimes a review of bank statements to show whether the company’s typical revenue is predictably ongoing.
Due diligence is also done on the legal side of things, like reviewing employment contracts for employees, going over corporate documentation such as a company’s corporate binder to prove ownership of the company, compliance checks, whether the business is appropriately licensed to conduct the type of business it’s doing, whether it owns the trademark(s) to the company brand, and so on.
Most of the time, a buyer can exit the deal if they find something in due diligence that doesn’t sit right for them, or if there are any red flags.
This is normally where the lawyers come in–at the negotiation phase. You’ll be taking the LOI (Letter of Intent) and using it to draft the actual purchase (or merger) agreement. Usually, the buyer hires their own lawyer to make the first draft because there are more details that will be important to the buyer (the seller usually just wants to get paid, so the details of the purchase agreement don’t matter as much).
Once the purchase agreement is drafted, it’s sent to the seller, who usually has their own lawyer review and edit it (AKA “redlining”). Each side will go over the changes and send redlined copies back and forth for awhile depending on how far apart they are and how important the provisions being negotiated are. The bigger the purchase price, the more that’s at stake.
If either side attempts to add in provisions that were not included in the LOI and are not customary for purchase agreements, a good attorney will return them to the LOI and argue that that’s outside the scope of the deal that their clients have agreed upon.
The vast majority of acquisitions are financed by commercial loans, so that the seller can walk away with a big check and not have to worry about getting paid by the buyer. Usually, a portion of the business’s value is linked to “intangibles” such as goodwill, brand recognition, ongoing customers, reputation, staff knowledge, and that sort of thing. Banks are often unwilling to fund the purchase of a business whose value is only in intangibles; banks prefer to make loans on hard assets like real estate, hardware, or inventory.
Thankfully, we have SBA loans, which stands for the Small Business Administration, which is a federally backed program that allows banks to make commercial loans that are more risky, that they wouldn’t normally make for companies with a lot of “intangible value,” as we talked about before.
To protect their loan, the bank will want to be involved with the purchase process. They’ll normally have their own in-house attorney or auditor who will review the purchase agreements and due diligence along the way, so as to ensure that the bank is making a relatively safe loan.
At Sparks Law, we’ve been drafting and negotiating mergers and acquisition agreements since 2013 and have learned a lot along the way! If this is your first acquisition or your 100th, we congratulate you on the opportunity and would love to help you to get a great agreement in place that protects your interests! Give us a call at 470.268.5234 or email us at info@sparkslawpractice.com, and we’ll look forward to speaking with you!
