Mergers and Acquisitions Explained: M&A 101 for Business Owners

Acquiring a business or merging two companies together can often feel like looking for the missing piece of a complicated puzzle.

If you're a business owner, entrepreneur, experienced founder, or just curious about how businesses are bought and sold, then this article is for you. Mergers and Acquisitions (M&A) are essential in the corporate world as companies buy and sell each other to expand their businesses, increase profitability, and achieve synergies. This article explains the basics of M&A, including the different types of M&A structures, the reasons why buyers and sellers engage in M&A transactions, and the critical players involved. Furthermore, the article answers common questions about M&A, such as "What is due diligence?" and "What are the 5 stages of a traditional M&A process?" Overall, this M&A 101 article aims to help beginners understand the multi-disciplinary process of M&A transactions, making it easier to navigate and understand the M&A landscape.

What Is M&A (Mergers and Acquisitions)

Mergers and acquisitions (M&A) are an essential aspect of the corporate world, where companies buy and sell each other to expand their business and increase profitability, and/or achieve synergies across the new enterprise - in essence, they are looking to create a new company where the whole is greater than the sum of it parts (1+1=3). 

The term M&A refers to the transfer of ownership, control, or management of a company or its assets. There are several classifications of M&A structures, such as asset sales, equity sales, or mergers. If you are an entrepreneur, founder, or business owner, understanding these deal structures is crucial to making informed decisions and executing a successful transaction.

In M&A, What Is The Difference Between an Asset Sale, Equity Sale, and Merger?

Asset sales are the most common type of M&A in the lower end of the market. In an asset sale, the buyer purchases specific assets of the company, such as computers, buildings, people, records, and contracts, and leaves behind any unwanted liabilities. 

Equity sales involve the transfer of stocks or partnership interests rather than individual assets. Equity sales are prevalent in the middle market, where buyers acquire an ownership stake in the target company.

Mergers are the least common type of M&A, mainly found at the higher end of the market. Mergers occur when two companies combine to form a new entity, and they are driven by complex tax considerations. The drivers of a merger are complex, but the paperwork is relatively straightforward. By operation of law, one of the two companies is left standing, making the transaction seamless. Mergers typically don't happen in main street transactions (a couple of million dollars) or lower middle market transactions (15 million to 250 million).

Why Do Buyers Buy, and Sellers Sell - M&A Explained

When a potential buyer is interested in purchasing a business, they will want to know why the seller is looking to sell. The reasons for selling a business can vary from wanting to retire, shifting focus to a new project or business, VC-backed investor pressure, or seeking a strategic partnership for growth. While there are no wrong answers to this question, certain responses can increase the buyer pool and drive up the sale price. Understanding the motivation behind the sale is an important factor for both buyers and sellers in the M&A process.

For buyers, a traditional path to growth can either be through an organic growth strategy, or to buy their way into a new industry or sector, product line, technology, user base, intellectual property, or new customers. For an acquirer, buying your way into growth can be faster and more efficient, especially when there are significant barriers to entry.

The Critical Players In An M&A Transaction

Business brokers and M&A advisors play a crucial role in facilitating M&A transactions. Business brokers typically handle main street transactions, while investment bankers cover higher-end deals. Both professionals have a similar skill set and help market a company for sale. They put together a teaser and then a Confidential Information Memorandum ("CIM") under NDA ("Non-disclosure Agreement"), which they use to market to local individuals, teams, or online marketplaces. Investment bankers have a much deeper buyer pool and can market a company to a more extensive network.

Corporate or business lawyers on both sides of the deal play a vital role in doing the documentation around the transaction, supporting the creation of purchasing agreements, deal structure, evaluating risk, assigning assets, and defining representations and warranties. Additionally, accountants, tax experts, wealth advisors, strategy, technology integration, and deal consultants are also likely involved in lower middle market deals.

In conclusion, M&A is a complex and multi-disciplinary process that requires proper due diligence, clear communication, and a well-planned integration strategy. Understanding the different types of deal structures and the roles of the various professionals involved can help ensure a successful transaction that benefits both parties involved.

Mergers and Acquisitions For Beginners - Q&A:

What Is due diligence?

Due diligence is a crucial (and often most time consuming) step in the world of mergers and acquisitions (M&A). It involves the thorough investigation of a potential deal or investment opportunity to confirm all relevant contractual details, company structures, Intellectual Property ("IP") and financial information of a potential buyer and seller. It is conducted before a deal closes to provide the buyer with an assurance of what they're getting in the M&A transaction.

The primary goal of due diligence is to reduce the risk of a bad business transaction by identifying potential defects or misunderstandings in a potential acquisition. Through due diligence, the buyer can obtain critical information useful in creating a fair business valuation and to ensure that the acquisition complies with the investment or deal criteria, also known as the acquisition thesis.

While due diligence is often conducted by the buyer, it can also benefit the seller. Sellers can prepare due diligence reports themselves prior to potential transactions to reveal that the fair market value (business valuation) of their company is more than what was proposed in an Indication of Interest ("IOI") or Letter of Intent ("LOI").

In the M&A due diligence process, a data room is a virtual or physical location where all relevant documents and information are stored and made available to the potential buyer for review. The importance of a data room cannot be overstated, as it is a central repository that streamlines the due diligence process and allows for efficient communication between the buyer and seller. It ensures that all parties have access to the same information, reducing the likelihood of misunderstandings or miscommunications that could potentially derail the deal.

Additionally, a data room enables the seller to maintain control over the information, as they can restrict access to certain documents or information until a certain stage in the negotiation process. Overall, the use of a data room is critical in the M&A due diligence process, as it facilitates the efficient and secure sharing of information, while maintaining control and confidentiality.

What are the 5 stages of a traditional M&A process?

  1. Assembling the M&A team responsible for the transaction: In the world of M&A, building the best team investment bankers, lawyers and tax accountants who are the leading experts in their specific industry is the most likely path to successfully selling your business. The right rolodex of buyers can open doors quickly. Specific industry knowledge can help identify synergies between the seller and a potential buyer in a way that brings both parties maximum value. Identifying the right team of experts for our client is a crucial first step in our M&A process and one of the most important strategic advantages Exitwise brings to the table.

  2. Strategy, preparation, and planning: As a founder, once you've identified the M&A experts on your team is in place, they will help you begin the initial phase of information collection to build out a data room, an online repository where key documents will be securely housed and shared in the next phase of the process. This information will also be the main source for developing company marketing materials that will be used to help merchandise the selling company to potential buyers. At this point of the process, a great Mergers and Acquisitions advisor will begin to identify potential acquiring companies with a track record of acquisition success.

  3. Marketing and evaluation of offers: During this phase of a business sale, the team begins reaching out to potential buyers. An exceptional Investment Banker, M&A Advisor, or Business Broker will tailor marketing messages and materials that will resonate with target buyers. Unfortunately, the wrong M&A advisor will often cut and paste boilerplate materials and send as a mass mailing to their list of 100 prospects. This is a recipe for compromising confidentiality and a failed sales process.

    Potential buyers who show interest at this phase engage in non-disclosures, review the seller's CIM ("Confidential Information Memorandum") and Q&A to learn more about the business and potential synergies between the two organizations. Furthermore, the seller and investment banker continue enhancing the data room.

  4. Negotiation and buyer selection: At this stage of the business sale, the M&A advisory team provides the first peek behind the curtain by opening a limited data room to give the potential buyer an overview of the company’s products and services, financials and management team. In addition, the seller's team finishes the full data room, which will eventually provide all the data needed to help close the sale with the final selected buyer. This is also the stage when the seller's M&A team begins selecting firm offers from the potential buyers, and creating competition to drive maximum value in a deal.

  5. Due Diligence and documentation: In the final phase of an M&A transaction, a buyer is selected, IOI ("Indication of Interest") and LOI's ("Letter of Intent") are accepted and reviewed, final terms for the business sale are negotiated and formal due diligence is conducted by the potential buyer. At this point, the seller and their team of M&A advisors will have walked the buyer through most of the product (i.e., Intellectual Property), business strategy, financial statements, and important customers and partnerships, so there should be no surprises that can put the transaction at risk. In addition, the final data room should be an open book, providing answers to every conceivable question about the company.

How do I get a proper business valuation?

Valuing your business accurately is critical to a successful sale or acquisition. But how do you determine the value of your company? There are several methods, each with its own pros and cons. The most common methods are earnings-based valuations, market comparables, income-based valuations, and cost-based valuations.

Earnings-based valuations are simple and easy to understand. They look at a company's past profitability and future earnings potential. However, they rely on imperfect assumptions to determine an acceptable capitalization rate. To get a more nuanced and complex analysis, you need to understand the net present value of future cash flows/earnings and consider appropriate industry multiples.

Market comparables are more helpful for service-based businesses, such as creative agencies or specialty clinics. This method involves comparing a company's revenues or profits to those of a similar competitor that recently sold to determine an appropriate sales or revenue-based multiple. However, finding similar companies that recently sold can be challenging.

Income-based valuations involve calculating a company's expected future cash flows using the discounted cash flow (DCF) valuation method. This method is a simple way to determine the value of an investment today based on future projections. If a company's DCF value is above the cost of the acquisition, the investment could result in a positive return on investment.

Finally, cost-based valuations are a straightforward way to value a company by considering the costs that went into creating the company. This method is commonly used in real estate transactions. However, it requires a lot of legwork to determine the initial capital, value of assets, and going concern costs required for the business to operate and grow indefinitely.

There are several methods to determine the value of your business. Each method has its own pros and cons, and the best method depends on the nature of your business and the specific circumstances surrounding the sale or acquisition. It is always recommended to consult with a professional to ensure that you get an accurate and fair valuation of your company. Let us know if we can support you during any step of your exit journey - whether you're early in the process of educating yourself on M&A, or think you're ready to begin the process of selling your business.

Where Else Can I Go To Get More M&A Education?

There are countless ways to educate yourself on M&A, many of which are low or no-cost:

  • Talking to entrepreneurs and founders that have gone through an M&A process

  • Joining professional communities that focus on business owners, CEOs, Presidents, and entrepreneurs (i.e., YPO, HAMPTON, TIGER 21)

  • Working with coaches and advisors that understand M&A, and can help you to understand and prepare for what a transaction process will look like.

  • Listening to M&A-specific podcasts detailing specific areas, ideas, and information specific to buyers, sellers, and mergers and acquisition professionals

Todd Sullivan.
Todd Sullivan

Todd graduated from Yale University where he was a 2-time MVP of Yale’s ice hockey team. After a year as a minor league hockey player in the San Jose Sharks and Toronto Maple Leafs organizations, Todd returned to school for his MBA at the University of Michigan where he graduated as Entrepreneur of the Year. Todd went on to build and sell four companies over the next 25 years with offices in Boston, San Francisco, Chicago, New York and Detroit. After the sale of his last business in 2015, Todd has dedicated his time to educating his fellow founders about the M&A process and helping many of them maximize the sale of their businesses.

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