THE RULE OF THREES. Oftentimes, life gives us three choices. When we were kids, it was Rock, Paper, or Scissors on the playground. As we got older, perhaps it was Dribble, Pass or Shoot on the basketball court, or Call, Raise or Fold at the poker table. When owning a heavy duty collision repair company during a time of potential consolidation, the choices are Exit, Expand or Exist.
This article is the first installment of a step-by-step, hands-on guide to the first two choices (we’ll assume that simply existing doesn’t require a lot of coaching). Subsequent articles will explore some of the motivations fueling mergers & acquisitions (“M&A”), the typical M&A process and flow, and the best practices from both a seller’s perspective (i.e., “The Exit”) and the “Buy Side”. If you are contemplating the sale of your business, or are considering an acquisition-based growth strategy, you won’t want to miss this column.
As a passionate student and practitioner of investment banking and corporate finance for over 20 years, getting a platform to share my thoughts on heavy-duty collision repair M&A is both exciting and a big responsibility. The Wall Street Journal has at least one M&A headline in every edition. Numerous academics have studied the effectiveness of M&A. It’s even sexy enough to make movies about it – think Michael Douglas as Gordon Gekko or Richard Gere as Edward Lewis. My goal is to demystify M&A; I hope the following articles help you gain a solid understanding of M&A best practices and prepare you for a deal whether you’re growing your business through acquisitions or you are looking to monetize your retirement by selling your business to a larger operator or private equity group.
As you read through these articles, please feel free to send me feedback, ask questions or suggest future topics. Thank you in advance for your trust.
DEFINITIONS. Before we have a history lesson, let’s agree on some definitions (for the purists and deal attorneys, I acknowledge that some of the following definitions may be oversimplifications – but they are adequate for these columns).
The “A” in M&A – Acquisition – typically refers to one company (the “buyer”) buying substantially all of the assets or stock of another company (the “target”), such that the buyer takes full control and the seller has little or no continuing interest in the business.
Acquisitions of small companies (i.e., US$25M or less in enterprise value) frequently are “asset deals”, which refers to the purchase of a target’s tangible (i.e., equipment, land, computers, fixtures, inventory, receivables, work in process, etc.) and intangible (i.e., brands, patents & trademarks, websites, phone numbers, customer lists, and, as much as possible, the company’s reputation) assets. Because the company/corporation is effectively stripped of its assets, but the legal entity itself is not acquired, the seller will continue to own the legal entity that sold the assets. This is notable because the legal entity will continue to retain any assets that are not purchased, as well as all of the liabilities not assumed by the buyer.
The alternative, a stock deal, is easier to understand because the purchaser is simply buying the shares of the corporation (or in the case of a limited liability company, the member interests). In a stock deal, the buyer gets all of the company’s assets as well as all of its liabilities. It’s just like buying shares in 3M through your online stock broker – except you would need roughly $120 Billion to buy all of the approximately 600 million shares outstanding.
Typically, all of the target’s stock or assets are included in a transaction. It is not uncommon, however, for a buyer to take a partial interest in a target. These partial acquisitions of stock can be “controlling”, wherein the buyer has majority voting rights or influence over key operational and strategic decisions, or “non-controlling”, wherein the buyer does not have enough ownership to make decisions unilaterally. Oftentimes non-controlling acquisitions are made by “financial” buyers that provide capital (i.e., money) to a company to be used to fund growth (i.e., acquisitions), in exchange for a minority share of the company’s future profits. On the other side of the buyer coin are the “strategics”, which are companies that generally are considered competitors or peers of the target company.
Non-controlling deals also occur when a strategic takes a minority ownership stake in a smaller company in the same or adjacent industry. This will occur when the larger company wants to prevent one of its competitors from acquiring the target, while not wanting to acquire the entire target (perhaps due to lack of money, or uncertainty surrounding the target’s business model, or countless other reasons).
The ”M” or merger, on the other hand, refers to a combination of two companies, wherein the owners each contribute the assets and liabilities of their respective companies to a new legal entity (let’s call it “NEWCO”) and then each owner receives an ownership share in NEWCO in proportion to the value that each seller contributes to NEWCO. For example, if one company contributes $6 million of assets to NEWCO, and the other company contributes $4 million, then the first owner will own 60% (6/(6+4)) of NEWCO. In a typical merger, the companies are combined and the management teams meld together to run NEWCO, with the management team from the company with the highest ownership in NEWCO getting ultimate authority.
There are other types of business combinations, including ESOPs (wherein the employees own the company) and Joint Ventures (wherein two or more parties invest into an entity and share in its risks and rewards, but the investors maintain separate identities), as well as trendy terms such as “acquihires” (which occur when an acquired company’s assets are primarily employees).
HISTORY. M&A has been taking place as long as there have been companies. Notable mergers occurred as long ago as the 1700’s in India and Italy. In the United States, the first big merger wave hit during a 10-year period beginning in 1895 when over 1,800 companies were consolidated into others. In 1900, the value of all M&A equated to 20% of the United States’ Gross Domestic Product (compared to 3% in 1990).
Merger activity can be measured broadly (at the “macro” level), such as the above trends, as well as at the “micro” level (e.g., individual industries). At the macro level, M&A activity is influenced by governmental policy, economic trends, interest rates, demographic shifts, etc. At the micro level, it’s primarily strategic reasons that drive significant M&A. For example, industries that exhibit certain characteristics (e.g., profitable, sizeable, easy to understand, etc.) tend to get “consolidated” – wherein a couple of large, dominant players evolve as the result of numerous acquisitions of their smaller rivals or peers.
The next article will examine the motivations fueling M&A activity as well as provide a primer on the typical steps in an M&A deal. Until then, happy dealing!