In the current low interest rate environment, and with the Australian and international economies showing strong economic growth, there's plenty of opportunities for mergers and acquisitions (M&As) among mid-market businesses. In this situation, the CFO's role involves working out which side of the deal you're on and prepare your operations appropriately.
If you're on the acquisition side, now is a very good time to ensure your funding lines are in place and you have the right skills in the business and experts to support you through a deal. If you are the CFO of a potential target, the best benefit may come from reviewing your business in the same way a suitor would and introducing changes to make it as attractive as possible.
According to digital data room Intralinks' latest Deal Flow Predictor, over the next six months the number of M&A transactions is forecast to rise by approximately 19% year-on-year. The industrial, energy and power and technology, media and telecommunications sectors are expected to be those with the most activity.
Tony Hood, Corporate Advisory Director at William Buck, says there's considerable activity in the media and advertising sectors.
“This is being driven by industry consolidation to achieve scale or proprietary IP. Offshore suitors are also increasingly in the market," he explains.
What buyers are looking for
Hood says acquirers are looking for businesses with positive earnings before interest and tax (EBIT) or future maintainable profits as a starting point – but will have more criteria. “People are looking beyond EBIT to what's driving it," Hood explains. He says the hot zone is firms with $2 million to $5 million EBIT.
When it comes to IP, firms that have proprietary assets with an artificial intelligence component are especially attractive. In terms of other non-tangible assets that are appealing, a good quality client base is a huge plus.
“Potential acquirers want to know if the business has a history dealing with quality blue chips, and if not, what the make-up of the client base is," he says.
Hood says local and overseas private equity firms visit his office on a weekly basis looking for specific assets that suit their mandate – and the market is very competitive and aggressive.
“I've been in the game for 28 years and I've never seen it as buoyant as it is today; having private equity firms looking around is really prompting a dynamic market," he says.
“In the last six months, we had one of the world's largest private equity firms swallow one of our clients as part of the consolidation process going on in the local market. The bidding frenzy was so significant we were able to influence the term sheet to achieve a higher net value for the client."
As a result, power is in the hands of vendors, which has been the case for the last couple of years. “Acquirers are buying growth through consolidation strategies," he notes.
Hood expects similar market conditions to remain in place for the remainder of 2018. “I've got no concerns for businesses going to market in the next six to twelve months. But it takes time for businesses to make sure they are market ready. So, I wouldn't delay taking a business to market in this environment."
Suitors are especially interested in the quality of the underlying business, and perform thorough analyses on the target's competitors and its relative position to them.
“It's not just about EBIT," Hood repeats. “Acquirers are looking into the underlying trends that make it up and are likely to contribute to it in future years."
Hood says when he takes a business to market, a business will generally have multiple revenue streams, each of which need to be forecasted into the future so the acquirer understands the target's profit-generation potential.
“Some revenue streams might demand a nine or ten times multiplier if they are based on recurrent revenue," he says.
An example is subscription fees for proprietary software; or a marketing firm with a sophisticated analytics tool. These types of revenue streams demand a far higher multiple than consulting services, for instance, which would typically attract a multiple of four times earnings.
“You do have to break the business down into its components and revenue streams and analyse each of them to take a company to market and achieve the maximum value for the enterprise," Hood says.
Thorough vendor due diligence will help the sale
Before selling an asset, vendor businesses are well advised to do thorough due diligence on their own operations, so management is well prepared to answer any questions from a potential acquirer.
“Be fully prepared to answer potential due diligence questions about any weaknesses in the business. If the vendor is not ready to answer these questions, it can detract from the ultimate transaction price or it can create a risk of the transaction not progressing. So, my advice to vendors is to thoroughly understand the likely questions that are going to be asked when you take the asset to market."
Warranties are becoming less common with transactions at the moment and Hood says if they are being used, the structure tends to be vanilla. “You can be tough and go for a very generic contract," he suggests.
In such a buoyant market, vendors are likely to get the best result when they sell both the sizzle and the sausage – not just the sizzle – and work with partners who will help them to achieve just that.
CFOs who can do that, will raise their chances to get the best price for their business, find acquirers for whom the asset makes genuine sense - and give themselves the best opportunity of a successful completion on the sale.
- M&A activity in the mid-market looks particularly buoyant at the moment, off the back of the strong global economy.
- Assets with registered IP and recurring revenue streams are very attractive to potential suitors.
- Vendors should undertake thorough due diligence to ensure assets are properly prepared for sale.