Mergers and Acquisition

This is a complex business and not for the faint of heart. While I have a fair amount of experience in M&A and private equity, I have found that a key success factor is patience. Why? Because if you are a buyer, you do not have control of the transaction until you are in due diligence and possess a standstill (exclusive) agreement. Even then, there is no assurance the deal will close. Moreover, if you are a buyer and the seller is somewhat unsophisticated, be prepared to wait…and be ignored…and have the process take many more months than it really needs to. This adds to the frustration and frequently casuses “deal fatigue”.

Over the past 10 years my partner and I have looked at well over 100 opportunities just in the restaurant industry. These operating companies generally have similar characteristics including number of restaurants operating in the chain; concept, sector, EBITDA margins and geography, among others. The interesting thing to note is that the common dominator regardless of size is how painfully slow the process, is that any deal can fail anytime during the process.

Bailiwick Consumer Group became a fundless sponsor about two years ago. We specialize in the lower-end of the middle market targeting chain restaurant acquisitions. Great business. Intellectually stimulating, financially rewarding (at least on a pro forma basis) and fun. It is also expensive to play.

So here’s the process:

Sourcing and qualifying
You better have some domain expertise and a full time job that actually pays you because it could take years…and years. Leverage clients, associates, professionals in legal and accounting as well as smaller investment banks. Get on their list of potential buyers. Also, if you like a business, initiate the call yourself to the owner. You should attend trade shows and conferences and subscribe to newsletters. Be in the business that you target.

Once you find an opportunity, qualify, qualify and qualify. Not just the business, but qualify the willingness of the seller to actually desire to sell the business. Qualify their understanding of the process, their flexibility in pricing and the hard work it will take to get to a close. Patience here is critical. You may find yourself doing a bit of missionary work as well as educating the seller on the ways of M&A. That is okay though, because you are building a relationship that will benefit the transaction.

Initial Due Diligence
This is relatively painless and shouldn’t take too long. But it can and usually does! In our experience, we only look at chains…restaurants with at least $3 million in EBITDA. So, we need to see financial statements for each restaurant for the preceding 12 months, a summary of all real estate leases and line item detail of corporate overhead or G&A. That’s it. The goal here is to determine what Company-level EBITDA is and evaluate the sum of the parts…ID the dogs if you will. If we have this data we will either proceed with a LOI or pass.

Letter of Intent
The LOI is generally non-binding and the purchase offer is subject to due diligence and should always include a standstill agreement to conduct financial, business, concept and management team diligence for a reasonable time frame. This locks up the deal so you can feel comfortable spending money and time evaluating the purchase and securing equity and debt financing. In some cases, the owners will ask for a deposit to be escrowed and applied to the purchase price. This shows good faith on the buyer’s part while providing a cash if the deal doesn’t close under the terms of the LOI. I will never do that again. Big mistake. Excuse me, but I am spending my money and my valuable time accessing your business to determine if I will write a big check. This is the part that always gets a little testy, especially if there is an investment bank or sellers’ agent involved. But, make sure the standstill is in place.

The LOI for a chain restaurant purchase is based on the trailing 12 months financial statements, so getting the most recent 12 months data will be like pulling teeth.

Thorough Due Diligence
We always try to get 60 days for due diligence, provided all requests for documents are delivered to us within 10 days of such a request. This never happens, so we generally have a lot of time to review the company. Then, we need 60-90 days to close…secure capital, work with lenders and equity partners to expedite their diligence, etc. So here we are at about 120-150 days not including delays on the sellers side. There is still no assurance the deal will close during or after diligence is completed.

Last year we identified a target, locked them up, secured LOI’s from a lender and a blue chip equity partner for 105% of the capital required to complete this transaction. At the last minute the equity partner decided they were clairvoyant about pricing and pulled out. We had to replace them…while negotiating a reduction in value of at least $2 million. This where some skill in negotiating will be valuable. The reduction was based on what we discovered during our investigation. Okay, we are now into this deal $50,000, 60 days into diligence, plus 45 days to get to the diligence period, so 105 days and we have no firm price and no equity partner. Essentially we have no deal. The bad news is that we are nearing then end of our exclusive period. This is a long story, but suffice it to say, we lost our deal 45 days later. Total time, 150 days, total cost in time and cash $150,000. In another posting I will elaborate on how to negotiate a fundless sponsor package with your capital partner.

Revisions, Revisions, Adjustments and Definitive Agreement
If you can get here, you are near to closing a deal. This where the real money is spent on legal, financial reviews in some cases audits, facilities inspections, real estate valuations, etc. Still, there is no assurance the deal will close.

Closing
Many times you will never get there and in some cases, it will be anticlimactic, after so much time. However, once the LOI has been replaced by a definitive agreement and escrow is open you are near the end. Now, there are a lot of details that take place between executing the documents and official transfer, but this blog entry is just about the process.

Challenges
On a small transaction, one less than $50 million, the financials, believe it or not, will be generally sloppy and the CFO, or VP Finance will not have experience in M&A. So, education and patience will go a long way to making a deal happen. The more you inure yourself to ownership, the more likely you will get to a close and less likely there will be a need for an auction. Always seek a negotiated transaction because bidding decreases the odds especially for a fundless sponsor.

We are in the process now on a new transaction, so I will keep you posted.