26 Sep M&A Structured vs. Managed Processes – beware of the hard due date!
In this episode, we are covering the importance of a detailed, repeatable process when it comes to maintaining timelines during an M&A process. Setting good expectations relating to preparedness, responsiveness, and inspection before, during and after a business combination benefits all parties for a win/win outcome.
Mike Harvath 00:04
Hello and welcome to this week’s Shoot the Moon podcast, broadcasting live and direct from revenue rocket world headquarters in Bloomington Minnesota. Revenue Rocket is the world’s premier growth strategy and m&a advisory for IT services firms. Today, I’ve got Ryan Barnett with me, my partner and we are going to unpack a very, very interesting topic. Ryan, want to give us a little lead in on that.
Ryan Barnett 00:32
Hey, good morning, Mike. And thanks for having us here today, We’re talking about the m&a deal process and specifically what we’re going to refer to as a structured process versus a non structured. And to give a little background here, when you typically go through an m&a process, as a seller, there are a number of big steps that you’re going to look forward to capstones. So I’ll give an example one of them is starting to is you’re ready to sell that’s kind of want to check the box, you got your number in your head and ready to sell. The second one after that might be putting together a list of companies who are going to go target them and start to have some conversations. The big milestone there being some introductory meetings and some kind of next steps and getting to know you a bit more. And it could be all the way to what for company might call an indication of interest, you know, that’s a walk through that term a little bit, but you might get an indication and interest that moves into a letter of intent that moves into due diligence and moves into a close. And when you think about this, that’s a fairly common structure that advisors will put there. The restructure that some what we call a more structured process. Mike, in your terms, what’s a structured process?
Mike Harvath 02:13
Well, you know, from my perspective, Ryan, structured process has everything to do with, you know, a controlled sale. And many, many brokers will run a auction, essentially, for your business, if they represent you. And that control process has pros and cons to it. You know, I we’re, we are hopefully, in a world where there’s some flexibility, but you know, and I would say we have differing opinions about what works best but but many, many m&a brokers will run a structured process and what a structured process looks like is they essentially pack into for sale, they then do outreach to find interested parties. And once they find interested parties, they’re creating very tight timeline on how quickly those interested parties can respond, based on their level of interest. Usually, they call for an indication of interest, after just producing the information, and the initial information for your review. And that indication of interest is hey, we think this firm based on what you’ve provided is worth x to x, we would have interest in this general deal structure, and, you know, we’re we’re, they’re raising their hands, those buyers are raising their hands as someone who has interest. Then, subsequently, after you, you know, receive a number of indications of interest, you move to an LOI deadline. And usually there’s a second phase of diligence based on those that have supplemented and IOI, and they look at, you know, other information and they either opt in or opt out at that time. If they continue to opt in, they will submit a letter of intent, which is more formal usually includes what we call a no shop clause. And in that situation, you know, you are, you will be in a position to accept or not based on where those letters of intent come in, and then you move down the road. And so, you know, from a high level, it’s a very managed timeline, and on the surface, that would look like a really good thing. However, there are some, you know, pitfalls of running such a process and you know Ryan you’re going to, we’re going to talk about some of those.
Ryan Barnett 04:54
Yeah exactly. So it takes a bit of finding that really well Mike the the clarity here I think is a it’s a call for time, so, and frankly, the limiting of an audience that that is going after. So, you know, we see this a lot more in industries outside of IT services, frankly. So if you’re running a restaurant, and everyone kind of knows what it is like to operate a franchise, there’s certain things that are understood and known and can be transferred quickly by understanding the operating model, the spreadsheets that go with it, and it’s a fairly limited knowledge transfer. So you don’t, you can move quickly, because there’s a large portion of knowledge that shared. IT services companies run, you know, so so much differently. So, there’s a lot of time that’s spent just understanding the three things that we think that are extremely critical to a deal, which is cultural alignment, strategic alignment, and if both those two are have alignment, then financial fit. And when you start to call down a universe and start to look through things in a lens, just financially process, and here’s the numbers, and here’s what it looks like, It’s like a much different view than if you’re taking a strategic view of how two companies can fit together. So if we just look at an IOI phase, and this is what happens oftentimes in structured deals is a broker may reach out to an interested party, and the communication can be something like we have an asset for sale, if you’re interested, we’d like you to have your indication of interest, which is essentially how much money we’re willing to pay in in 15 days. And, Mike, I don’t know about you, but I mean, when you’re on the buy side, it’s hard to do anything or put it together a number with limited information, and not having met a team.
Mike Harvath 06:57
Yeah, for sure. Ryan, I think what’s interesting about the whole idea is that, you know, you are going to dramatically limit the number of buyers that are in the pool by running a process. Most likely, you’re also going to remove a lot of strategic buyers, who may not be able to fully vet the opportunity within the timeline as a lot of so what ends up happening is you tend to lean much more towards financial buyers. And the problem with purely financial buyers, is that you may be missing some of those components of cultural or strategic alignment. And simply be highlighting financial alignment. And to your point earlier about, you know, it’s common to run a process for businesses that are alike or similar or, you know, I little hesitant to use the word commodity, but certainly, you know, one particular type of restaurant franchise runs very similar to, you know, another restaurant in the same franchise, for example, their business systems are saying the protest of the market is saying that their numbers may be different, but in the end, they’re very similar. So the ability to understand those and how they may impact a particular buyer’s profitability and return rates is pretty easily understood. In the case of an IT services company vastly different and I would say the same for any, if any people based business. So if we’re looking at, you know, any human capital based business where you’re selling time or services, that makes it very, very challenging to kind of run these tight timelines and processes effectively, and really find a suitor that will, you know, have all three pillars of what we feel are critical and deal so you know, strategic cultural and financial fit actually be vetted.
Ryan Barnett 09:04
Yeah, I think the the critical those fillers are critical and IT services we have to have alignment and cultural understanding of what people do and how they work. And if you try to jam that together without an introduction meeting first, it’s really difficult to understand that. And I think sellers can get swept up a little bit and understand okay, who’s going to make it to that next stage? The plus side, again, I’m thinking more just IOI stick stage here, It certainly must feel good to understand by August 15, you’re going to have 10 suitors you you are or you aren’t going to have 10 suitors. But if you only have one you feel good about it feels it could I think it could also feel really defeating. But it’s nice to understand at least by XYZ date, I should have something that’s out there.
Mike Harvath 10:07
Yep, yep, for sure. And I think, you know, you know, just to kind of share our philosophy on this point, you know, we don’t necessarily believe running a truly structured process with deadlines is in a seller’s best interest in IT services. We believe that it’s better to sort of take all suitors and have a little bit more of an open market view of it. And the reason for that is because, you know, as long as your expectations of value are in alignment with the market, you’ll pretty quickly get to finding the right suitor and the right buyer by doing that. And you’re not going to put artificial pressure on buyers to respond to a specific approach or deadline or whatever. Because in many cases, like in the case of family offices, for example, almost all family offices, given a structured process will opt out as a buyer. And we, as a firm, historically have done have been very successful in working with family offices with buyers for sell side mandates, and/or representing family offices on the buy side. And we know it to be the case that almost all of them, I don’t want to say all because it’s you know, pretty hard to make that statement, but in our experience, almost all of the family offices, and certainly all family offices we’ve worked with, have opted out when they are trying to acquire a company, if using a structured process, yet, these guys are typically long term investors buy and hold type investors have a lot of capital, tend to, you know, be very diligent about how they make their investments, and that they’re more like a strategic buyer. And so, you know, when you begin to look at things like that, you know, you’re going to exclude all the family or a majority of the family offices, you’re going to begin to exclude a big portion of strategic buyers. You know, you start to say, Well, then why run a structured process, if suddenly, you’re down to a very short list of predominantly financial buyers, which, you know, may or may not, I mean, certainly there’s great financial buyers out there that have done great transactions and, you know, have great platform companies, or maybe they’re bringing you in as a platform company. I’m not disparaging financial buyers, I’m just saying that the only ones that can really act fast enough in a in a process of structured process, our financial buyers, because they have a lot of analysts and folks sitting around the table that can look at the data and quickly synergize it, I don’t know that you want to it’s in your best interest of the seller to be ruling out a huge, you know, huge communities of buyers because you have a desire to go fast.
Ryan Barnett 13:04
And I will note that in a what we would term an unstructured process there, you’re still vetting out multiple buyers. At that, one thing that changes quite a bit is the timeframe and the pressure that get I would say it’s an artificial pressure for someone to quickly move forward to that loi, that loi stage. So they either we have a podcast that I’ll refer back to, how to evaluate multiple buyers and multiple offers. The goal of any broker should be to to bring multiple people to the table and have adequate representation offers that are in the best interest of the seller, and and making a win win deal for for everyone. And I think sometimes when you get into the structured process, just even the timing, can quickly throw someone off and not be willing to participate. And you’re could be missing your best suitor out there. Mike, I want to transition in just just a tiny bit because I think it’s in the same vein, when you have some a bit of a structured process, I believe some firms think that it’s going to turn into a financial auction or bidding war. And I’d just love to give your general perspective on you know, do auctions work in the IT services market?
Mike Harvath 14:35
Yeah, they don’t, they don’t really. And the reason why they don’t is because the buyers come to doing their analysis and come to an offer sort of on their own timeline. And, they’re not going to be forced, their hands are not going to be forced, generally it’s been my experience so to run in a particular time box. Sometimes, because maybe they’re, they have a certain financial resource on their side that’s on vacation or might be out of the office or might have a backlog. And they’re a great buyer, you know, I don’t think you want to rule them out, because you need to give them an extra week to do their analysis, or that they need some specific data. And the way they do analysis that’s not included in the first round of information disclosures are, there’s a lot of reasons why I think you have to be more nimble than that. And, you certainly will get multiple buyers that coalesce at the same time, that’s our experience. But it’s difficult to force everyone to come to the party at the same time. And I think it’s just it, again, you have people that will opt out, if they’re forced to do so. And so I think it takes the nor nuance and skill, frankly, to manage the multiple bidders situation, it is in your best interest to have an advisor or or broker such as revenue. Raka are one of the, you know, firms that are in the market to do we do for IT services companies to do that. Because, you know, barring that, and just running a very rigorous timeline. As I said before, it just it just eliminates the correct buyer. I think also we’ve seen, and I’ll just share that the likelihood that there’s a retrade, and what I mean by a retrade is that the transaction from what’s agreed to in the letter of intent to what ultimately gets offered in the definitive agreement are different, goes way up in a situation where you’re trying to run a control process or an auction. And the reason for that is, is there’s there’s not generally enough time for the buyer to effectively do the early phase pre diligence and pre offer in order to fortify it enough, in order to ensure that it will not be retraded. Generally, deals get retraded If there’s something that’s discovered in diligence that’s materially different or negative from what’s been discovered before the letter of intent is completed. And in that case, that’s a that’s a legitimate reason to retrade, aka, maybe the business hasn’t performing well, between the time the LOI was signed and you’re going to close or, you know, maybe there was something that you know, the buyer overlooked, but you dramatically increase that chance of error on behalf of that buyer if you’re trying to run an auction or trying to run us a process. And ultimately, that can lead to the deal not closing and the whole process failing.
Ryan Barnett 18:00
And just the emotional side on the buyer, the rush to put something forward and just to continually be pressured to have something by a certain date or you’re out, I think leads more towards inaccuracy to your point to that you just become it’s very easy to give up on the deal. And there’s a delicate balance between sellers and I stopped putting light where I still think we’re in a seller’s market, so there’s an opportunity here to be a little bit faster. But ultimately, you want this transaction to be successful with people that you want to work with for a long time. And that is a that’s difficult to do when you when you when you only have an hour or two total to meet someone before putting together a letter of intent that is meaningful, and going to stand out through due to through due diligence. And that I’m going to talk a little bit out of our side of our mouth, I do think if you can have a bit of a hybrid approach here, in that if there are enough suitors on the buy side, or, if you’re selling if you’re taking your company to market and you have got a wide range of suitors and you have multiple offers on the table, I think it is fair to have a date for an indication of interest. If you feel like you’ve vetted out a fair number of of buyers. Mike, any thoughts on that? Kind of I would say hybrid approach of if you’ve done enough here, we’re calling, we’re moving to the next stage.
Mike Harvath 19:47
No, I think there’s there’s value in managing expectations right. It can’t just be an open ended you know, do whatever you want for as long as you want and you hope that you’re going to get to an offer that makes sense That’s because you know, hope or a wish is not a plan. So you need to have a plan, right. And a competent broker will have a plan and a timeline for which to manage the engagement. And it is a managed, an actively managed process, not a passively managed event that occurs when you sell your business. And I think that takes time and resources. So, you know, when we say, you know, a, you know, when we talk about, you know, that a structured process versus a managed process when we think and manage processes, certainly much more effective- and that’s the term we’ll use, and that’s managed by an advisor, and it’s one that is more thoughtful, and one that actually has much better statistics for likelihood to close, much higher rates of valuation, and much more favorable deal terms, typically for a seller. And so, you know, you need to be managed at a minimum. And I think structured, you know, in IT services doesn’t work for all the reasons we’ve already talked about.
Ryan Barnett 21:21
Yeah, that’s, that’s a great way to sum it up, Mike. Any last comments?
Mike Harvath 21:28
No, that really, I mean, I think, you know, certainly, at this point in time, you know, the market continues to be very robust for m&a. I know everyone’s kind of waiting for the shoe to fall the next shoe to fall on m&a, like hey we’re gonna start to see remarkable down downward pressure on valuations, are there going to be, you know, issues related to the economy or headwinds or whatever, we’re certainly not seeing that. You’ll be the first to know, if you regularly tune in here on our weekly podcast, revenue rocker that we see it will let you know, but we’re certainly not seeing that. We think the market is going to remain pretty darn healthy for the foreseeable future. And so you know, as you think about being a seller, if you’re contemplating coming into the market, or even buyers, there’s certainly some, there’s some great companies out there that are well run that are healthy, that can be targeted, you know, we would welcome the opportunity to have a conversation with you, even if it’s just to share observations about the market. And if you need some assistance, getting to market whether you’re a buyer or a seller, we would welcome that opportunity to participate in your manage process.
Ryan Barnett 22:48
I appreciate that and we would love to guide you through that and walk you through know what we feel is the appropriate process and a timeline with that. So Mike, with that, we’ll turn it back over to you and you know what to do.
Mike Harvath 23:03
Yep, so that will tie a ribbon on it for this week in Revenue Rocket world. We look forward to you tuning in next week when we’ll unpack and explore more relevant topics in IT services, m&a and growth strategy. And with that, make it a great week.