September 2017 | Point of View

Speed is the new differentiator in mergers & acquisitions

Speed is the new differentiator in mergers & acquisitions

Today's savvy investors know that it takes more than a compelling offer to win. It requires a faster pace to edge out the competition.

But moving quickly to submit the earliest bid comes with risks — namely, abridged access to information and an inability to get the investment committee comfortable based on traditional and thorough due diligence. How can investors move fast to capitalize on an investment opportunity offered at auction while hedging against risks of the unknown?The past two years have seen historic levels of M&A transaction value, exceeding $2 trillion in both years. Deal values are at all-time highs and multiples in many sectors are soaring, driven by increased levels of competition among buyers with cash to invest, as well as a pressing need to drive future growth and investment returns. For example, the median EBITDA multiples for software M&A deals globally has grown to 14.6x, up from 10x in 2012. We see three trends contributing to this intensified competition:

  • Continued low interest rates provide favorable lending conditions for buyers.
  • Private equity firms are fundraising at a record pace, while institutions, sovereign wealth funds, high-net-worth individuals, and pension funds are seeking returns from alternative asset classes. Private equity firms are anxious to invest and deliver returns to these limited partners, and they are capable (and often willing) to pay higher prices than historically acceptable deploy the capital.
  • More private equity firms are moving down market or starting venture or growth funds to look at lower/mid-market companies, raising the level of competition for attractive deals at almost any size. Then throw strategic companies or corporations in the mix – those looking to achieve synergies or buy into revenue streams to achieve the growth their shareholders demand. Stir these ingredients in a pot and, not surprisingly, you have a highly competitive environment.

The effect of heightened competition: Only a few buyers get access for proper diligence 

Today’s M&A landscape is increasing the number of auction-style deals, where bankers attempt to capitalize on heightened levels of competition among potential buyers to drive up bid prices. In these situations, potential buyers typically have less time and opportunity to conduct the diligence necessary for submitting a prudent bid. Auctions attempt to accommodate buyers’ needs for information, but not to the extent traditionally exercised.

More often than not, 'diligence' has been reduced to reviewing prepared presentations and virtual data rooms sparse of documentation until the final stage.

A banker may “stage gate” 20 potential bidders and then narrow the field to five or eight. At each round, bidders gain more insight into the target’s inner workings, intellectual property, and trade secrets so as not to expose confidential information too broadly. Only the two to three finalists end up with access to any meaningful data and information.

Strategic buyers have the synergies, but private equity has the speed

Historically, strategic buyers have held an edge in a competitive M&A environment, with their available revenue and cost synergies, allowing them to offer higher prices. Increasingly, though, bidders with competitive advantage are those that can move the quickest, have the lightest touch, and provide a bid within expectations – although not necessarily the most lucrative bid. (Remember: Some sellers are looking for the best cultural fit, ease of closing, provisions for retaining key leaders, or other priorities).

Today, private equity buyers have the advantage of speed, being able to submit an offer with more unknown data points than a strategic buyer would be comfortable with. Accordingly, they are often in a better position to take calculated risks based on less information. They may pare back their requests for documentation or perhaps submit a typical diligence questionnaire, but highlight a short list of the most critical items.

Maximize your chances for success with four strategies

If speed makes the difference, then how can today’s buyers navigate the accelerated diligence process without sacrificing their level of comfort with the risks involved or their ability to model an investment for a healthy internal rate of return? If you expect to be a potential party to an auction, consider the following imperatives for conducting sufficient diligence and preparing a fast, yet confident bid:

  • Have trusted advisors that know the target’s industry well — very well. Your advisory team should understand and pinpoint where issues commonly reside and how they can manifest over time. When you compress diligence, you still need to look for the smoking gun and not just the fire. An experienced advisor should help you streamline your diligence request/questionnaire to focus on the most relevant and important matters. For example, a private equity firm acquiring a healthcare business might focus its limited diligence time on security and privacy to avoid a catastrophic event like Anthem’s $115 million settlement. A software investor, like many in our recent survey, may want to focus limited diligence time on technical factors – particularly scalability in line with planned growth, followed by legacy technical debt and required investment to address.
  • Engage advisors as early as possible. While it is natural to want to keep your interest a secret, you will need to balance that with the ability to move quickly for competitive advantage. The earlier your advisors know, the better prepared they can be with the right resources when helping you analyze the opportunity, prioritize requests for the target and its bank, and prepare a sensible bid. This is a situation where a little trust can go a long way. Ultimately, stripping none-core elements of scope from advisor reviews should help save time, but should not compromise the push to obtain evidence supporting material findings and viewpoints.
  • Prepare yourself for the reality of dealing with more “unknowns” than usual. Having less access to information may require you to be a little bolder. It also requires you to be more calculated about the nature and materiality of the unknown, and buffer the financial model accordingly. Here again, experienced and knowledgeable investment team members, operating partners and a cadre of advisors can help minimize the breadth and depth of that uncertainty – but the ability to deal with less certainty than normal starts inside, with a healthy understanding of the investment thesis and how that impacts your growth objectives/strategy during the hold period.
  • Start “day one" planning immediately. With more unknowns, the first 90 days becomes even more critical. Plan your post-close diligence carefully, triage issues immediately, and assemble the right team of internal leaders and external partners to manage a smooth transition.

Not all investors will be comfortable with a speedy approach, but potential bidders in an auction must be prepared to deal in a new, different, and faster way. The more you know about what to expect, the more prepared you can be to move at the market’s pace.

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