Since 2015, UQ have been asked to undertake a range of reports and projects to help customers understand the landscape ahead of them. This is due to a change of circumstances, a change of strategy or a willingness to grow. Over the last 2 years, this type of research and support has been classified by a number of global consultancies as “Integrity Due Diligence”
Within UQ, we view Integrity Due Diligence (IDD) as all non-financial areas of insights and intelligence that add value into a companies’ growth strategy. This could be relative to M&A activity but also route to market strategy, recruitment and retention of talent and successful bid management.
IDD includes available public records sources such as corporate and compliance databases, subscriptions, journals, and media. In addition, UQ undertake third party interviews and reviews with key individuals and supplier’s past and present, to look to add depth and context to the insight. Within this service, UQ identify and profile across a range of topics. Such as: – Reports are usually bespoke to each customer but link a number of the above areas of interest within the research phase. Integrity Due Diligence (IDD) service is now essential in doing business as to ensure the correct resource and investment package is allocated to each and every opportunity. Want to learn more? UQ Merger & Acquisition Support Learn More Target Sourcing & Selection Once the company has determined that an acquisition fits with its wider corporate strategy, the next phase is to identify potential targets, synergy opportunities and to arrive at a valuation. Learn More Defining Screening Criteria Affordability – potential acquisition targets are reviewed in terms of market capitalisation, revenues, net assets value Learn More Synergy Expectations The synergies available can be significant and are often the reason for the acquisition. Synergies can be difficult to quantify and their capture is uncertain. It is therefore essential that they are considered carefully throughout the M&A process. Learn More Executing the Deal Having determined that M&A is consistent with the corporate strategy, identified and valued the target, the deal must then be executed. At this stage, identification of key issues within the target business can make the difference between a successful deal at the right price and an expensive failure. Learn More
M&A strategy
In considering whether M&A is the appropriate method to improve shareholder value, performance and market competitiveness, a company should first review its corporate strategy.
Corporate strategy makes the company greater than the sum of its business units, and sets out the organisation’s direction and goals, business portfolio, resource allocation and growth plans.
A corporate strategy review is critical for success. However, it is often neglected by executives under pressure to achieve short term results. One of the primary causes for acquisition failures is a lack of insight into the target company, its core competencies and limitations, and changing market conditions.
The rigorous analysis conducted in a strategy review enables a company to understand its internal strengths and external market conditions over the coming few years. This analysis helps to develop a set of prioritised options, such as an acquisition or divestment, to achieve its objectives.
As challenges and opportunities for growth are defined, options to defend, grow, fix or exit can be assessed and prioritised based on the company’s goals, capabilities and financial position. Generally, companies can choose from a myriad of strategic objectives such as:
Depending on a company’s strategy, acquisitions may serve as a way to quickly achieve strategic and financial objectives.
TARGET SOURCING & SELECTION
Once the company has determined that an acquisition fits with its wider corporate strategy, the next phase is to identify potential targets, synergy opportunities and to arrive at a valuation.
Developing a pool of targets
In assessing investment opportunities, a company should evaluate the attractiveness of the sector in which it plans to conduct an acquisition by:
Once the decision is made to pursue opportunities in a sector, the company can begin its preliminary research on potential acquisition candidates.
Developing the acquisition candidate pool
The first step in a target selection process is to develop a long list of potential acquisition candidates. This involves a high-level search based on criteria such as:
Often a search will come up with more than 100 potential candidates in the long list. These potential candidates will be further screened and profiled.
Sourcing potential acquisition candidates
Finding the right candidate, a buyer or a seller, requires time and patience. A search for a target requires an extensive review of potential candidates before finding one that fits a company’s strategic needs, whilst being fairly priced.
A company could identify potential acquisition targets by conducting internal analysis or using its own network. Some business owners would search openly for a buyer whilst others would identify potential candidates through:
Affordability – potential acquisition targets are reviewed in terms of market capitalisation, revenues, net assets value;
shareholding preferences – i.e. determining the desired level of control over the target and defining a criteria for either a majority or a minority shareholding;
Operational
Collecting target data
Availability of target data in the UK is generally good. UK companies have to file publicly available financial statements on an annual basis. These must be audited wherever a company exceeds certain size limits. For listed or quoted companies, more regular reporting is required and information may be available from investment analyst coverage.
Prioritising targets
Buyers should prioritise potential targets according to the number of screening criteria the target companies fulfil. This is also an opportunity to establish under what circumstances the company would walk away from one target and move on to the next.
Prior to approaching the target company, additional research and information gathering should be conducted by a financial advisor to provide a more complete picture of the candidate. This would include information on ownership and management teams in the target companies, and include subjective elements such as family situations and succession plans (e.g. the willingness of children to take over the business). Very often, negotiation levers are identified during this process.
An experienced lead advisor will:
The synergies available can be significant and are often the reason for the acquisition. Synergies can be difficult to quantify and their capture is uncertain. It is therefore essential that they are considered carefully throughout the M&A process.
An initial part of due diligence is identifying potential synergy opportunities between targets and the buyer. Only targets that bring additional value to a company should be considered in an M&A exercise.
A synergy may be defined as the increase in performance of the combined company over what the two companies are already expected or required to accomplish as independent companies. Put simply, synergy is either the revenue enhancing or cost savings achieved by integrating.
Revenue enhancing synergies. A revenue enhancing synergy results in additional revenue above and beyond what the two companies are expected to accomplish independently. Revenue enhancements promote higher returns and facilitate long-term growth more than cost savings, but they tend to be difficult to quantify. Most initiatives that can enhance revenue can be grouped into:
Identifying and reviewing synergy opportunities is critical to determining whether a candidate company should be further considered as an acquisition target. Selecting the appropriate target will enhance the performance of the buyer after integrating the entity
Having determined that M&A is consistent with the corporate strategy, identified and valued the target, the deal must then be executed. At this stage, identification of key issues within the target business can make the difference between a successful deal at the right price and an expensive failure.
Evaluating the target
It is critical for the company Directors to consider both the risks and rewards associated with a prospective acquisition. In broad terms the due diligence would seek to understand the underlying profitability of the business, the identification of potential liabilities and exposures, and any matters to be addressed in the integration of the target’s operations into those of the acquirer.
The scope and depth of the review will depend on many factors, including the complexity, size and geographical spread of the target’s operations. It is important that the due diligence is performed by professionals with a balance of financial and sector knowledge.
Due diligence would normally include a commercial review of the market and competitors, a detailed review of the historical financial performance of the business, a review of the target’s tax affairs to identify potential exposures and tax compliance, and a robust review of the target’s business plans. The due diligence would also cover an assessment of the target’s financial reporting procedures and management capabilities. The negotiation of the sale and purchase agreement (SPA, see 6.4 ‘Finalising the transaction’) is a critical part of the process – contractual provisions are built into the SPA to protect the acquirer from the impact of potential exposures identified as part of the due diligence process.
Investigating management
In recent years it has become commonplace for acquirers of UK companies to conduct background checks on the target and senior management (the Subjects) – frequently referred to as Integrity Due Diligence (IDD). These checks seek to identify information that can assist the acquirer both with better understanding the Subjects and identifying ‘red flag’ information that may be found on public records.
IDD checks on UK targets involve searches through a wealth of UK public record information. Companies House not only holds a company’s filings (such as Financial Statements and Annual Returns), but also a list of those individuals who have been disqualified from holding UK directorships. A wealth of information is also held in media databases, which cover both specialist and national press, with some articles even dating back to the late 1980s. Litigation databases are also accessible and, whilst they don’t cover criminal records (which are not a matter of public record in the UK), they do cover certain criminal cases heard by the Court of Appeal. Also available to the public are records covering insolvency or bankruptcy and civil debt judgements awarded against a company or individual by a County court.
Assessing the target’s operations
In most cases the deal execution starts with an initial understanding of the target via an Information Memorandum (IM). However, the operational due diligence will provide a broader insight into the target’s operations as it will allow the acquirer to compare the target’s operational performance relative to its industry competitors.
Operational due diligence is increasingly being used by corporations and private equity firms to help identify operational risks and/or opportunities in a target. Typical operational risks might include separating a division from its parent company or the successful delivery of a planned operational restructuring/performance improvement initiative, which often support forecast EBIT growth (Earnings Before Interest and Tax). Operational opportunities identified during a due diligence typically include cost synergies from the post merger integration, or the identification of potential opportunities to deliver performance improvement/cost reduction within the target.
The target’s operations are assessed for their ability to support the forecast assumptions that underpin the target’s valuation: outputs, costs, quality, delivery, cost savings, management structure and capabilities. The diligence can then be refined and enhanced as access to the target and further information become available.
Deal structuring
A buyer should generally structure the transaction by taking into account the needs expressed by the seller as well as their own requirements. There are many ways to structure and specify terms for a transaction. Essential to formulating the optimal transaction structure, the buyer (with the assistance of a financial advisor) should:
A buyer can either buy the shares from existing shareholders or directly acquire the assets from the target company. Acquiring shares tends to be more popular than acquiring assets because:
In addition to the financial structure of the deal, buyers may also consider management, assets, tax and financing issues, in order to structure the transaction in a way that suits all parties involved
Continuity in management
The continued employment of management is often subject to considerable negotiation. A buyer often considers the management team as a key asset in an acquisition, particularly if the buyer is a financial investor. Under such circumstances, employment agreements are often negotiated with key people, specifying terms, responsibilities, remuneration, and equity participation. Buyers should recognise that retaining existing management would provide continuity in business operations while slowing down cultural integration.
Consideration
The consideration a prospective buyer can offer may be in the form of cash, notes, stocks, shareholders loans, or a combination of the above. Since each form of consideration has different implications and liquidity, the transaction price may be subject to further negotiation depending on the form of consideration offered. The two most common forms of consideration are cash and stock. Figure 11 summarises the characteristics of each.
Contingent payouts
During price negotiations, points of view may diverge on business forecasts. The buyer may believe the growth rate will be lower than what the seller presents. Considering that the price might be based on forecasts provided by management, it is critical to make sure that the figures are as accurate and achievable as possible. One way to break the impasse may be a contingent payment agreement, where additional payments will be made only if the company meets certain pre-defined goals after the transaction is completed.
Before signing any Sales & Purchase Agreement, both parties should understand that there is a chance the deal may not happen for the following types of reasons:
There are many factors that may halt the M&A process. Whether a company will want to search and pursue another target will depend on a number of factors – strategic need, business conditions, morale of the M&A team, and time already spent.
Overall, tax considerations must be integrated into other areas of the deal. For example, all of the above structuring has to be achievable within the legal framework of the jurisdictions involved, so ensuring that tax and legal advisers work closely together enables a complete and workable solution, as opposed to one that works for tax but which is not capable of being implemented for legal reasons.
