With mergers and acquisitions on the rise, it’s increasingly important for businesses to understand trends and best practices for a successful transaction.
The biggest trend is strong, widespread interest in buying companies as an investment — and a huge amount of money is waiting to be utilized solely for that purpose.
Family offices and individuals with significant wealth are concerned about the stock market, and because interest rates are low, they aren’t buying bonds. Instead, they’re choosing to invest in companies. Because of the proliferation of high net-worth individuals interested in buying, we’re seeing increased private equity activity involving funds supported by multiple investors.
Increased demand means purchase prices are at historic highs. This means two things. It’s a seller’s market, and purchase price inflation has led to increasingly large “air balls,” or differences between the purchase price and asset valuation, which determines the amount of debt a buyer is willing to take on to buy a company.
The financing process grows more complex when the air ball is larger, as the lender must decide whether they’re willing to lend enough to bridge the gap. If the sum unsecured by collateral is too large, a bank may not approve that loan if the air ball hasn’t been accounted for elsewhere in the deal.
For example, if a buyer purchases a company for $10 million and that company owns $7 million in collateral assets, there is a $3 million air ball in that transaction. The purchase price gives the appearance of $3 million in additional net worth, but in reality, the additional value isn’t there.
Strategies for a successful deal
Below are some tips for a successful transaction.
Take your time: In many cases, issues surrounding M&A deals typically arise from moving too quickly.
Sometimes a deal requires a quick turnaround, but it’s critical to carefully consider each element of the transaction. Signing the contract before securing financing, discussing financing with the other party before talking to your lender, or failing to assemble a team of key players early enough in the process can all make the transaction more complicated — or completely fall apart.
Be discreet: Buyers sometimes make the mistake of showing their hand too quickly.
Ideally, you want to avoid indicating that you’re a motivated buyer. If the seller knows the buyer is desperate and willing to overpay, they may have more leverage in the deal agreement.
Perform due diligence: From a financial perspective, failing to stress test the deal to account for unforeseen losses or performance decline is a major problem and can lead to the deal collapsing or unexpected issues after closing.
Completing a careful analysis and forecast can help ensure this deal works now and in the future.
Consider the people involved: Getting the numbers and details right is critical to a successful deal, but it’s equally important to think about the impact of the merger on company culture, employee retention and client relationships.
Failing to consider the potential people-driven risks involved in a deal can leave buyers with client attrition or unexpected holes in leadership teams. It’s crucial to build relationships with clients and employees and address cultural concerns proactively.
Find the right partner: With so many factors impacting M&A deals, the job of a lender goes beyond financing the transaction.
Tom Terry is chief lending officer at UMB Bank.
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