15 Apr Buy-Side M&A: Tackling the most Challenging task of Finding a Willing Seller
Sourcing sellers is very difficult as an IT Services buyer. Today, we are walking through tackling buy-side M&A outreach and what does a buy-side process look like overall.
How do you source sellers on your own, and why is it so hard? Here are some of the questions we are digging into in this episode:
- What is buy-side M&A
- Why should companies be considering buying other firms?
- What goes into buying a company?
- What’s hard about sourcing when your doing the deal yourself?
- How do you create the list?
- How do you reach out to buyers?
- How do you determine value?
- How do you craft a LOI?
- What do you need to do in Due Diligence?
- How do you deal with disagreements if there are no advisors?
- How do you get through legal log jams?
- Why should you use an advisor?
RELATED EPISODES:
Episode 164: Elements of a Great Introduction Call. Listen now >>
Episode 163: Strategies to Manage High Seller Expectations. Listen now >>
Episode 155: A Short vs a Long LOI. Listen now >>
Episode 129: Questions to Ask Before you Consider an M&A Initiative. Listen now >>
Listen to Shoot the Moon on Apple Podcasts or Spotify.
Buy, sell, or grow your tech-enabled services firm with Revenue Rocket.
EPISODE TRANSCRIPT:
Mike Harvath 00:05
Hello and welcome to this week’s Shoot the Moon podcast, broadcasting live and direct from Revenue Rocket world headquarters in Bloomington, Minnesota. If you’re a regular listener, maybe if you’re not a regular listener, revenue racket is the world’s premier growth strategy and M&A advisor for tech enabled services companies. Today, I’m fortunate enough to have my partner’s on the podcast. Both Matt Lockhart and Ryan Barnett. Welcome.
Matt Lockhart 00:34
Hey Mike! good to be with you. Ryan, what’s going on?
Ryan Barnett 00:39
Yeah, appreciate everyone getting the call and listen to this today. We heard again this week, from a few podcast listeners. And it’s always great to hear from you. So if you have any comments, questions, or something you’d like to hear discussed, please let us know at info at revenue rocket.com. And, and we’d love to discuss what’s on your mind. As we work through this podcast, our focus really on IT services firms and the black art of mergers and acquisitions. But today, something we’re going to tackle is is a, I think, a very interesting question, which is oftentimes, when you’re looking at the acquisition market, it feels like a like a buying a company should just be easy. And if you talk to a firm and you talk to someone in the space, you find that what we would affectionately called buy side M&A. Or another way you may call it sourcing sellers. It can be a really difficult job and it’s just it’s just really, really hard. And today we want to walk through that concept of what does buy-side M&A look like, can you attack or some opportunistic operation? How can you tackle things opportunistically, if that opportunity is and what does that biocide process look like overall? So, Mike, why don’t you get us started on just what is buy-side M&A?
Mike Harvath 02:12
Yeah, the frame the thought, you know, buy-side M&A is really about sourcing targets as either a buyer for yourself or on behalf of someone else. advisors do that, of course regularly on behalf of someone else. But it includes a material research function. That is least identifying the target companies and to doing outreach to them to gauge their interest in doing a deal, either with you if you’re the buyer or with someone else, if you’re an advisor, and in the world of you know, buy side m&a, that origination function, that’s where it all starts is very challenging. And we’ll unpack that more as we get moving. Beyond that, you know, buy-side M&A also involved all the things that are go into determining the value of that business. And I think you using proven models, if you’re going to try to roll your own there that are I think, reasonably well published, as well as using an accounting firm or finance expert or valuation advisor, M&A advisor, is prudent, partially because they have a credible firm has, has a method or an approach for that that’s been repeatable and oftentimes is vetted with very recent comparable transactions that help you kind of ground them in reality. And then, you know, beyond that, of course, there’s all of the negotiations that go into kind of working through the legally binding agreements. Certainly after the valuation, you have to get to an LOI, which is not binding, but at least formulates the structure of the deal. And everyone’s willing to do and formalizes the understanding around it. And then moving into diligence to confirm that what that seller is selling is really what it is. And then working with legal counsel to you know, find the agreement if you will have a legally binding set of documents and ultimately get the deal closed.
Ryan Barnett 04:28
So buying a company, it’s it’s a process there’s what I just heard you say there’s a start that goes and find just finding a buyers. The very, very, very start on this and that’s one of the biggest challenges in the whole thing. But going from from start to, what we might call origination to close and through the final kind of money’s all settled up and transferred. That that’s a hefty process. Absolutely. Yeah, yeah, and bad. I mean, well Why Why is M&A important? I mean, what why do firms do this at all? Why should a company who maybe growing organically consider inorganic growth through an acquisition of a company?
Matt Lockhart 05:12
Yeah, well, variety of reasons. I think that the sort of at the highest level, take a look at the leading firms in just about any industry, but certainly the leading firms in tech enabled services technology all together. And, well, I think every firm that would fit in the top quartile performance has an ongoing in organic growth strategy, right? So first and foremost is is if you want to, if you really want to compete, and you want to be recognized as best in class, well, you know, put yourself alongside that peer group of firms and every single one of them is, is looking at growing their business and growing their value through buy-side M&A. Now, for a variety of reasons. You know, one could simply be, and this is something that I’ve done personally, which is you want to expand your market coverage, you want to expand your serviceable market area. And, you know, location matters, even today, you know, post pandemic, you know, where remote work is at an all time high. And customers are, are more accepting of doing work via teams or via zoom or on a call, being able to be close to your customers, to be in market, to have some level of business development and service capability within market is, is still a real strategic strategic advantage. And one of the important levers for growth. So, you know, you may be looking to expand your market coverage, you may be looking to expand your service capabilities, I’ll say you’re a great MSP, and you’ve started to build security services in but you know, recognize that it’s hard, and, and it’s, you know, it’s not like flipping a light switch, and all of a sudden, you’re experts at security, and you have the depth of experience, and you have the credentials, and you have the customer stories. And that’s hard, and it takes time to build up. And so you may be looking to make an acquisition, to further your, you know, your overall capability set. Wow, yeah, I mean, shoot, we’re on teams today, which is one of Microsoft’s greatest products, right? Well, you know, go back into the history of teams and see how Microsoft started. And you might be surprised to see that there were some acquisitory activity related to that. So that’s an example of you’re going to expand your capabilities. And it should, it could be that you want to demonstrate a higher growth rate, because you may have intentions yourself of, of looking at future investment partners, and you want to demonstrate your value in being able to grow faster. And one of the fastest ways to grow is to capture new revenue sources through through acquisitions. Can you know, similarly, you want to get into a new tier of profitability and and EBITDA generation and some firms have want to be able to go faster, and they see an opportunity to, to purchase an entity that is very like minded, like capabilities, but it just expands their throughput to through throughput to the bottom line. And so yeah, it’s a variety of reasons needs to fit in with an overall strategy. You know, we advocate and counsel our clients that their, their inorganic growth strategy is in line and is really part of their overall strategic plan. It’s not something you know, over on the side it really couples with If their overall strategic, you know, three to five year strategic plan, and what we see with our clients is that they’re able to decrease the timeframe to value creation through by side and inorganic growth.
Ryan Barnett 10:18
I think there’s a huge ton of great reasons of why companies do M&A. And it’s, I think it is it’s such a natural progression of a company to help get over those hurdles to expand the team expand their capabilities, and to take that next share of market. And, Mike, I’d love to get your opinion on this, when you think and your greed and you and you say, Okay, let’s go buy another company. What are some? And you mentioned some of the processes that are there. But what what goes into buying a company? What should What should someone be prepared for maybe one or two things that they a company should think about when when buying buying in their first firm.
Mike Harvath 11:08
I mean, if you’re if you’re a first time buyer, and you’re thinking about and I know a lot of firms are going through this process right now, in no small part, because they’re all getting multiple calls from buyers, themselves and seeking to see if they’re looking to sell and they’re like, hey, well, maybe we’re in a position to buy, you know, certainly you have to be in a position to take some risks. Because M&A comes with risk. And it is going to be something you have to dedicate a lot of time to, if you’re going to, well, we like to say roll your own or trying to run this on your own. And it takes always more time than you think it will. So you know, there’s risks, there’s time and there’s money, you need to come to it with a strong balance sheet, you need to be bankable, likely many of our you know, folks we’ve talked to that are looking to do transactions will finance that transaction or use some other financing partner, or do a fundraising exercise or, you know, be in a position to you know, fund it through debt. But if you’re going to do that, you need to be able to secure that debt in you have to go into a confidently with a clear or clean balance sheet with some material reserves on that balance sheet in order to move forward.
Ryan Barnett 12:33
That helps out I think you said a great risk time and money, I think, big components to it. Now we hear a lot of times where someone is able to come up with a deal by maybe someone they know or or they do kind of falls in their lap. In reality, when you start searching for a company, it’s a one of the most unnatural hardest acts in business. And Matt, I guess I’d love to get your perspective. You know, what’s what’s hard about doing this by yourself? And what’s hard about trying to just go simply by another company sounds pretty easy if I show up with a bag of cash that I can just do this, right? Yeah.
Matt Lockhart 13:19
If it were only so easy, right? You know, speaking to that opportunistic mindset, you know, one of the things that we see is, is that nothing comes easy, especially in in organic growth and, and m&a. And we know because we’ve been doing it for 25 years, then by side m&a in particular is just extremely difficult. Sure, you do hear of some opportunistic stories where you know, something fell into somebody’s lap, but that is, you know, the vast minority of situations, sort of going back to what we were talking about before, it really should fit into your overall strategic plan. And to think that something just opportunistically is gonna fit, right, that strategic plan and what you’re trying to do, is it’s not, it’s not reality. Another thing is, is, you know, we’re very, very strong proponents, that the very best firms to buy are those that are not on the market today. And so you may think to yourself, Well, I’ve sort of educated myself on on all the M&A advisors and investment banks that play in my space and, and if I can, if I can just be on the radar for when they bring deals to market, well, then I’m gonna have all the opportunities that I need and I don’t need any help, right. Well, that’s not reality. either, because when, you know, when firms go to market, there’s gonna be a lot of competition. And the competition for those firms that are going to market likely either have a corporate development department themselves, or they are working with an advisor, to help them position effectively, and to go fast in the process to give themselves a chance to win. In addition, you’re typically going to be paying up when you’re, you’re approaching firms that go to market. So to be most successful, you’ve got to be able to canvass the entire market, and you need to grind it takes time to get people to pick up the phone to pay attention to the opportunity to position effectively right from the get go, when you’re able to make an introduction to those firms. And, you know, again, doing that yourself is is well, it’s a full time job. As a matter of fact, it’s many people’s full time jobs. And so to think that you’re going to be able to do it individually, unless you built your own corporate development department is well sort of wishful thinking. Yeah. And there’s just let’s get into the guts of it. Ryan? What, where do you start? Right? In the process, and and I think that that sort of conveys just how hard this is?
Ryan Barnett 16:38
It’s a great question, Matt. And it’s, and that’s something that, you know, I truly admire, I’ve seen some individuals in the space who are really understand that, and they have built networks, and they have built almost personas around what they do. And they’ve been able to, to be in the market in that corporate development call. And, and, and some of your listeners today, appreciate the efforts that you’ve got, you know, finding a company is hard. And I think part of if you are to go, you know, if I was to get the question, well, how would I go create a list? I think there’s a lot of study and thought of, you know, what are the criteria that are important to you, in that what we would call an ideal prospect profile. And I think about things like the geography in which I want to be the size of the company that I’m able to take a part of or to be to take a look at the focus areas or service areas and technology service areas of the firms that we’re looking to acquire. I’m interested in companies and their their management intention, or their founding dates, I’m interested in their financial problem, their financial status, and their ability to be accredited to earnings and very interested in their culture. So all those things are start to come together to look at a holistic firm, hold our company in a holistic way. But then you start to create the list. If I think about that, let’s say that we’re trying to target application development firms that are in the northeast, I still have to have a methodology that allows me to go find those firms to be able to validate the revenue that’s there, be able to, to make sure that they fit our strategic vision, and ultimately, to what is also about an extremely hard part, which is simply contact and reach out to these buyers, what you’ll find is that the process, especially if you’re with article, that article about it, it’s it’s a it’s a grind, and it takes time. And part of this is if you’re asking someone to, to sell their life’s work and try to monetize their life’s work, and to give up your life’s work for anything, even at that big paycheck is such a hard consideration. You’ll find that it on average, it takes us about 12 attempts, just to get someone to say hello, for us to have that initial conversation. Which tells you that the market that we go after has got a pretty big frenzy of just trying to get through and break through to the right people. And to go through that process to find the right person on the line that meets your criteria and meet strategic, cultural, and financial thresholds is is something that takes a bit of an art to come up with the profile. But a lot of them work and and hard work just to make those conversations happen and make that a reaction so you can find the get to a point where you’re actually able to have a deeper conversation around a potential fit together and a finance whole financial solution there.
Matt Lockhart 20:02
Well, when you talk about that, it’s there’s a lot that goes into it. But, hey, I’ve got three hours on the internet every night. And you know, I bet you I could just go create that list. Well, again, not reality, but say, you get that list? And is it as easy as just sending an email to people? And and then Away you go, or how do you? How do you get about getting people to pick up the phone and get an actual conversation?
Ryan Barnett 20:38
Yeah, I have resorted to feeding a lot of carrier pigeons these days, just as in reality, it does take work, it takes consistent hard work to execute. So it mentioned in earlier the just the sum of its pure attempts, I will say that you have to have a very dogged effort and a very systematic approach to getting a hold of someone. I mean, my sister doesn’t call me back. And, and she’s family. So if I can imagine a stranger tried to call you back is likely, much harder than getting your old family member to call you back. And so I can imagine, with the right systems in place, the right approaches in place. And frankly, time, a lot of you know, we talk about that three legged stool of financial fits, strategic and cultural fit, there really is a fourth leg here, which is timing, and getting people to the time and the right at the right place. And sometimes you never know when you call someone at three o’clock on a Friday, and they have had their wits end, and they’re like, I am tired of dealing with the day to day, it’s time to talk about what a bigger vision for me looks like. There’s some some magic that happens there. Eventually, we do find someone and as is, if we’re counseling somebody on the phone, and they were able to find an ideal prospect, Mike, would affirm do to determine value. Now, how does a, how does a buyer understand what a seller might be worth?
Mike Harvath 22:30
Well, ultimately, all value is is determined by a willing buyer willing seller coming together with some sort of pricing terms. So I’ll just frame that up. First of all, now, there’s some pretty well established norms in our industry around what determines, you know, the right enterprise value. And there’s been a lot that’s been published by us and others on that front and sort of that you can figure that out. But there’s no real way to get a more reasonable objective view of value. then by hiring an experienced valuation advisor, someone who is either an M&A advisor or you know, CPA or accountant or valuation firm to do that valuation. And they’ll have a much more accurate view of the world. I know a lot of people like to try to run a valuation based on a multiple, some multiple they heard at the country club, or they found a surfing the internet or, you know, heard from maybe even an M&A advisor, but multiples are not valuations and vice versa. They’re just a guidepost to determine, you know, if there’s a reasonable probability of potentially getting a deal done. And, you know, certainly for firms that are under a million bucks in EBITDA, let’s say, you know, those ranges are kind of in the five to six times trailing 12 month EBIT, if you’re comfortable with that number, that the EBITDA is actually accurate. There’s all kinds of issues in trying to determine value. That is a thumbnail sketch of a firm. Because the smaller the firms get, the less mature they are as it relates to their financials. Are they doing accurate and defendable reporting? Do the owners of that firm have any sort of realistic context for what their business is worth? Many times we see those guys don’t have that. They have a number in their head of what they would accept to exit that has nothing to do with fair market value in the marketplace and or for the business. And the smaller the firms you target the more It seems those guys have those gaps in their understanding as it relates to their financial maturity, and just around expectations of what’s possible to pay to acquire business in the space.
Ryan Barnett 25:17
Right, that’s a great point, it takes a lot of work just to get to a deal in crafting a winning LOI. And I think that’s something that gets overlooked a bit is, is the art of the letter of intent. And, and, Matt, what makes that LOI so hard? It feels like a deal terms have got to be a large portion of that.
Matt Lockhart 25:44
Yeah, I mean, we’ve it’s matter of fact, if you go back to you, there’s we did a whole podcast on the creation of an LOI, you know, most important is determining the, you know, the first swipe at at enterprise value, right, and, but also, how you are thinking about the the deal in terms of term structure, right? So, do you want an urn out? How are you positioning the arena? Is there an opportunity to roll equity, you know, and obviously, you you want to seed all of these things prior to an LOI. But then have them can come through consistently, but not in the way that it would come through in a definitive agreement. So important to keep in mind that any of the term and or value aspects of an LOI are going to be non binding, right. And the majority of the LOI is going to be non binding, say, for some lockout provisions and confidentiality provisions. And so you know, how you position it in a way that is going to be accepted, not favorably accepted, but then enables the conversation to continue forward in a healthy manner towards what is going to be the very best definitive agreement for you as a buyer. But then also for both parties, because you know, if it’s not, then a deal isn’t going to come together. And so there’s some art to it. You know, again, sciences, most of the thing is, is non binding, you want to make sure that you’re setting the appropriate expectations. You want to make sure that you’re keeping yourself in the game. And you’re doing it in a way that that the seller sees as a as a positive step forward.
Ryan Barnett 28:03
It’s definitely it’s a tricky, tricky part. And I think it’s one where that handshake, once it’s established is is a lot of trust is felt on that. But it’s going to it’s going to change throughout that definitive agreement, a lot busier dealing with a different set of personnel. Once you get that loi done, you’re starting to move into due diligence. And that’s something we just did a podcast on that as well. It’s there’s a lot of work that goes into understanding the assumptions that went into crafting that LOI. So getting through due diligence of inequalities of earnings, or having a risk based approach that is very critical towards the success of getting a deal done. Mike, I guess I’ll turn it up over to you to kind of have some last thoughts here. But it’s, there’s so many tasks that are here in trying to buy a firm. What parts do you think can a buyer do by themselves? And where do you think they should use the advisor?
Mike Harvath 29:14
Well, I’m a little biased to your rank, because I think, you know, if you value your time in you, quote, unquote, stay in your lane, as I like to call it, you would use an advisor throughout the entire process. Now, some of the challenges depending on the size of the deal, if it’s either very small, or you know, in a in a very specific context, you might not be able to find an advisor that would sign up for that deal. And that is a real consideration. So, you know, assuming that’s the case, I think you can begin to network your way potentially into a deal and, and do origination on In your own, you know, if you’re looking for maybe bringing couple firms together in a merger, that sometimes it’s a little easier to originate. I know a lot of folks in the, in the various peer groups have certainly hooked up and said, hey, you know, we should merge or we should think about doing a deal and, and those have been originated on their own and they’ve been, you know, pretty darn successful all things considered. We can point to some examples there. So, origination is difficult, but it may be an area where you can kind of, you know, roll your own and get out there and see who you can find either through networking with other professional services firms, like accountants, or lawyers, or might know someone who’s in the market might be interested in exiting, or peer groups or other ways, you may be able to find your way or just calling those owners directly in and doing a little networking. I think when you start getting into, you know, hey, we’re kind of interested. Now we need to have someone help guide us, that’s the time to probably bring in an advisor, the deal facilitator, typically, they can do a valuation, they can help you kind of come to fair value and structure and get a letter of intent executed. And then, you know, assist with the diligence and sort of all of the management and rigor that goes around diligence and beginning to advise around getting the deal done. Certainly, there’s other advisors, you’re going to need to bring in, you know, whether that be accounting advisors, or tax advisers, and certainly legal advisors to help get the transaction done. Someone who is focused on helping you navigate the business landscape and the business terms, is a good investment. Because remember, if you lean on your lawyer simply for that, and lawyers have a very specific role to play here. But they should be focused on the legal terms, in generally not the business terms associated with the deal. You know, we believe that it’s more efficient, to have people that are facilitating these deals or managing M&A deals in the space, from a business context, kind of handle that stuff, and then have the lawyers work together to find the best legal document language between the buyers and the sellers. If you do that you’re going to do you’re going to be far better off almost all lawyers want to wade into the business terms, conversation, but they have very little context about a particular industry typically. And don’t always add the best value there. In you just need to make sure that you’re, you know, leaning on the right people for the right job.
Ryan Barnett 32:57
And I think we used term earlier, but it’s it truly is one of the most unnatural acts in business. So to go from the start of finding the right firm, all the way to getting through that signed agreement and off to what we’d call post merger integration is a is a heck of a trip. And if you are opportunistic, and you can take the path, I think especially if you’re smaller and looking to grow, that is something you should consider. And you might be able to piece together that those first deals on your own. Once you start looking up market and you’re starting to look at some of those bigger plateaus and hurdles, I think it helps to bring someone on board to help get your goals achieved in just with with the advisor who may help your percentage of success. Thanks. Thank you both Mike and Matt. Matt, any final question before kind of we summarize and wrap it up?
Matt Lockhart 34:02
Well, I guess I just say, you know, continue to strive to get into that top quartile and inorganic growth and an ongoing inorganic growth strategies is one of those keys. And you know, of course, we’d love to talk to you, Mike.
Mike Harvath 34:23
I think without will tie ribbon on it for this week shoot million podcast. Make it a great week.