By Ray Carpenter, GPG Capital Partners, LLC
Whether dealing with the sale of an entire EMS company or a corporate division, achieving the best possible terms and net present proceeds should be your primary concern. Selling a business is often the most important decision a company owner will face and it is a decision that can occur at various stages of a business career for various reasons. The process is time consuming and can, if the seller is not diligent and organized, have a negative effect on a company’s ongoing profitability and growth prospects. Nevertheless, selling a business at the appropriate moment to the correct buyer can unlock significant value that will reward years of hard work.
The sale process can be characterized as having six separate phases:
- Organization/Objective Analysis: In this phase the owners, management and/or the board of directors (1) put together a project team, including an investment banker, an attorney, accountants and internal management personnel; (2) educate the team about the business to be sold; (3) establish goals with respect to the sale; (4) identify a list of prospective purchasers; and (5) decide on a sale strategy.
- Pricing Analysis: The investment banker will help to determine likely market values for the business utilizing several valuation techniques that are relevant to the specific situation, including (1) comparable company analysis; (2) precedent transaction analysis; (3) discounted cash flow analysis; (4) leveraged buyout analysis; and if necessary (5) a liquidation analysis. The value of the business will be influenced by a variety of factors including financial performance, industry dynamics, competitive position, technological developments, M&A and debt capital markets environment and market timing.
- Marketing and Approaching Potential Buyers: In this phase, the project team works closely to prepare an offering memorandum that describes the business as it is presently being conducted, as well as its potential for expansion. Potential buyers are approached and asked if they would be interested in acquiring the business. If they express interest, a confidentiality agreement is forwarded for their signature, prior to distributing the descriptive selling memorandum.
- Due diligence phase: In this phase, buyers are permitted access to the management and facilities of the business. Typically, management of the business makes a presentation describing the business and significant additional data concerning the company is made available to prospective buyers.
- Negotiations: In this phase, a buyer or buyers are selected for detailed negotiations regarding a purchase agreement.
- Definitive Agreement and Closing: The negotiations lead to the signing of the definitive Purchase Agreement. The closing of the sale takes place soon thereafter.
There are several reasons to hire an investment banker. One is to access the contacts and market knowledge that an investment bank has. Another is that the investment banker should be able to significantly reduce the amount of disruption caused to the business and permit management to continue to focus most of its time on running the business rather than running the sale process. Third, an intermediary provides major advantages during negotiations. The investment bank can insulate its client from the misunderstandings and ill will that often occur, and put forth proposals and ideas in negotiations that do not necessarily have to be accepted by the client. Finally, an investment bank can usually complete the transaction very quickly. Also, a competent attorney, either from inside the company or outside counsel, should also be added to the team early in the process.
Once the decision to sell has been made, the owner/management must select a team of internal people and external advisors to work on the project. The principal outside advisor is a competent investment banker.
The initial task for the investment bankers is to familiarize themselves with the business. They will conduct extensive, up-front due diligence to maximize their understanding of the business and the owner’s personal goals and objectives. One of the first items for the team to plan is how communications with employees and customers are to be handled. The decisions regarding such communications should coincide with the desire for confidentiality in the sale process.
The objectives analysis and discussion should also serve as a forum for the owners of the business to outline any other objectives they have in the sale (e.g. putting their employees in a good corporate home, making sure that the firm’s employees are retained, or making sure that management gets a piece of the equity in the company).
The client and his investment banker will also compile a list of buyers (the “List”) for the business. This List will include all the parties known to be interested in businesses similar to the one being sold. The banker will make sure to include on this List the organizations that have contacted the company in the past about the business to be sold and the competitors and other companies that management believes may have an interest in acquiring the business. Generally, the resulting List will have three categories of buyers: domestic strategic buyers, foreign strategic buyers and private equity firms, potentially including current management. It is typical for the List to be categorized according to some subjective measure of probability of interest (e.g., “A” list buyers versus “B” list buyers).
Once the list has been completed, the investment banker will recommend a selling strategy based on the objectives for the transaction. This strategy deals with whom to contact, when and how to contact them and the process for moving forward with them in the event they are interested in acquiring the business.
After due diligence has been gathered and corporate and personal objectives have been defined, the investment banker will prepare a valuation analysis.
The investment banker will help to determine likely market values for the business utilizing several valuation techniques that are relevant to the specific situation, including (1) comparable company analysis; (2) precedent transaction analysis; (3) discounted cash flow analysis; (4) leveraged buyout analysis; and if necessary (5) a liquidation analysis. The value of the business will be influenced by a variety of factors including financial performance, industry dynamics, competitive position, technological developments, M&A and debt capital markets environment and market timing. This analysis should also include the estimated tax aspects of the anticipated transaction, so that the after-tax proceeds can be forecast. This valuation analysis serves as a basis for establishing realistic expectations in the sale, including expectations regarding the type of acceptable consideration.
If an owner has unrealistic expectations in a sale, this is the point at which they should be confronted. Otherwise, the owner/management runs the risk of putting the organization through a tremendous strain for nothing. An unsuccessful sale can also potentially create an image in the marketplace that the business is “damaged goods that couldn’t be sold.” Such an image could depress the value of the business in a future sale.
Owners, managements, and board of directors of EMS providers decide to sell businesses for a wide variety of reasons, including strategic considerations, a cash flow crisis, lack of family members to continue the business and many others. The reason for the sale is important because in certain instances it will directly impact the decision about the process that will be used to sell the business. For example, if the decision to sell is made because of a looming cash flow crisis, the company may not have the time to conduct a Two-Stage Auction Process. It may be limited to a quick sale to the most likely strategic buyer.
There are numerous sale strategies that an investment banker and his client might devise. However, broadly defined they tend to fall into four types:
Marketing and Approaching Potential Buyers
- Public Auction: In this approach, a public announcement is made indicating that the company is “exploring strategic alternatives” with respect to the business. This announcement is often made at the point when the company has just completed the descriptive selling memorandum. The purpose of the announcement is to alert the entire business community that the company is considering the sale of the business and that any interested parties should step forward and contact the company right away. One of the business reasons for making such an announcement, aside from the possible legal requirements, is that the number of prospective interested acquirers is quite broad and a public announcement is determined to be the best way to adequately address the full range of potential acquirers. Generally, this type of approach will elicit numerous interested parties, assuming that the business is not in distress. A major negative associated with making a public announcement is that it tends to increase the amount of disruption caused to the business.
A Two-Stage Auction Process will probably be used to maximize value in a Public Auction. In a Two-Stage Auction the investment banker contacts a number of prospective buyers at the same time as the public announcement, and distributes descriptive selling memorandums to qualified buyers, who sign confidentiality agreements. The descriptive selling memorandums will be accompanied by a cover letter indicating that indications of interest (“Indications”) are due on a certain date. Once indications are received, the company, in consultation with its investment banker, will narrow down the list of prospective buyers that will be permitted to continue.
The companies allowed to continue to the second round will be given access to management, a tour of the business’ facilities and access to a data room of information about the business. Second round participants will also be given a draft purchase agreement, which they will be asked to review and mark up for any proposed changes that they would require. The second round will culminate on a certain date, when bidders will be required to put forward fully financed offers. Once these offers have been submitted, one or more bidders will be selected to negotiate final definitive purchase agreements.
The purpose of selecting more than one bidder at this juncture is to maintain the competitive spirit of the process while the final agreement is being negotiated. Once the final agreement is signed a closing typically would occur shortly after the expiration of the applicable Hart-Scott-Rodino and other applicable government-related waiting periods.
During the 1980s the Two-Stage Auction Process was used for the majority of sales handled by Wall Street investment banks. Today the Two-Stage Auction Process is still used in a majority of sales handled by Wall Street firms. However, this process should not be used if the business to be sold is particularly complex or the financial structure of the transaction is very unusual.
- Controlled Auction: In a Controlled Auction, the number of prospective acquirers that are contacted is limited to some extent and no public announcement is made concerning the availability of the business. Generally, the Two-Stage Auction Process is used to narrow down the number of prospective buyers.
One of the realities that managements fail to adequately anticipate is the fact that the business being sold will generally become common knowledge to many industry players, even if the Controlled Auction involves a limited number of prospective buyers and they all sign appropriate confidentiality agreements. This event must be planned for.
- Targeted Sale: In a Targeted Sale, a very limited number of strategic buyers are approached concerning their interest in acquiring the business. No public announcement is made concerning its availability.
A Targeted Sale strategy is chosen when it is believed that the list of prospective buyers that could pay an acceptable price is quite small. If the Targeted Sale strategy is chosen, it is unlikely that a Two-Stage Auction Process will be used. It is more likely that a Single-Stage Process will be utilized.
In a Single-Stage Process each party contacted that expresses an interest will be given a descriptive memorandum upon signing a confidentiality agreement. Once a party has reviewed the descriptive memorandum, it will be given access to management, the facilities and a data room if it indicates that it could reach a valuation range that is acceptable. An alternate process that is often used is to let all targeted buyers who are interested proceed to the due diligence phase without indicating where they are on valuation. The goal of this approach is to get prospective buyers more interested in the business before requiring them to indicate their valuation thinking.
The process in a Targeted Sale is often more open-ended than either the Public Auction or the Controlled Auction. While many times the Targeted Sale works like the second round of a Two-Stage Auction, there are also instances where there is no definitive time frame for submission of bids. This reflects the thin nature of the interest for the business.
- Negotiated Sale: In certain limited circumstances, there is only one buyer for a particular EMS company. This typically occurs in situations where the business to be sold is physically adjacent to the prospective buyer’s operations, fits perfectly into a prospective buyer’s portfolio of products or is jointly owned with the prospective buyer and contract rights give the prospective buyer the right to buy the interest he/she does not own. In these circumstances, a Negotiated Sale strategy is often chosen.
When a business is to be sold in a Negotiated Sale, there are generally no strict procedures laid down. Rather, negotiations begin and proceed at a fairly leisurely pace, reflecting the seller’s desire not to appear overanxious to the buyer. If it is at all practical, the seller should attempt to bring in a competitive bidder or “Stalking Horse” to move the process along more quickly. In addition, it is highly likely that such a move would improve the offer price from the likely buyer.
Once the strategy for selling the business has been agreed upon, the company and its investment banker can finalize the Time and Responsibilities Schedule. This document lays out the time frame for completing the sale, the individual tasks that must be performed to reach a successful conclusion and who is responsible for completing each task. However, a deal can be completed in as shorter time frame than this schedule suggests. Generally, sales take between three and nine months from the date the process is started.
Preparation of Descriptive Memorandum
During the preparation of descriptive memorandum phase of the sale process, the investment banker conducts an extensive investigation of the business. The investment banker’s investigation is designed to provide an understanding of the business and the industry it operates in. This includes the current set of dynamics affecting the industry, the strengths and weaknesses of the business to be sold, the outlooks for both the industry and the business and the quality of the management team running the business.
Based upon the review of the business, the investment banker will prepare a first draft of the descriptive selling memorandum. This draft will typically be refined over a series of meetings and result in a document that fully describes the present operations of the business. More importantly, the document should describe in some detail all of the significant opportunities for expanding the business from its present scope. Such opportunities include the ability to produce other products with existing facilities or market additional products through present channels of distribution.
One of the important decisions to be made about the descriptive memorandum is how complete it should be. Should it be merely a “teaser” that only gives a broad overview of the business, or should it be a comprehensive memorandum that addresses all the major issues/opportunities facing the business? The answer generally depends on the expected audience for the document and how knowledgeable they are about the company and its industry. It also depends on how much confidential information the selling company thinks should be released in an initial memorandum that is widely distributed.
Approaching Potential Buyers
During this phase potential buyers are contacted regarding their interest in reviewing the descriptive selling memorandum. Generally, the investment banker will call an appropriate official at each potential buyer’s organization. Depending on the circumstances, this may be the chief executive officer, the chief financial officer, the president/general manager of one of the subsidiaries, the corporate development officer, another corporate officer or its investment banker.
However, if the number of potential buyers is limited, the seller and/or its investment banker may personally visit with these buyers to present the opportunity face-to-face. Such an approach is designed to elicit a quicker, more direct response from the potentially interested parties than a mere phone call. The personal touch tends to give the prospective buyer a greater feeling that he can negotiate a transaction rather than just participate in a standard Two-Stage Auction Process.
Assuming a prospective buyer exhibits interest in proceeding, a confidentially agreement is forwarded to the buyer immediately. Once this is signed, the process continues.
During the due diligence phase, prospective buyers are permitted access to management, the facilities and a data room. Typically, management of the business makes a presentation to all prospective buyers that outlines the business and its prospects in more detail than appears in the descriptive offering memorandum. In a Two-Stage Auction, the amount of due diligence that a prospective buyer is permitted is limited. In other circumstances, the amount of due diligence can be quite extensive.
During the due diligence phase, prospective buyers are often given a draft of the purchase agreement that the seller is willing to sign concerning the sale of the business. The buyers review and mark up this draft with proposed changes as part of their due diligence effort.
One of the investment banker’s primary responsibilities during this phase is to supervise the collection and dissemination of due diligence data. This reduces the burden on management and the disruption to the business.
Negotiating Definitive Agreement and Closing
After negotiating the definitive purchase agreement, if necessary, all applicable government filings will be made and closing will take place after the government clearances are obtained.Once the due diligence phase has been completed, final bids are requested for the business. Once the final bids are received, the seller, in consultation with its investment banker, will generally select one or more parties with which to negotiate a final purchase agreement, assuming there is some amount of negotiation necessary. These negotiations will focus on firming up the representations and warranties that the parties will agree to. Such negotiations often have an impact on the final price.
For the individuals involved, the sale of an EMS business is a very significant step and one that often requires much thought, preparation and planning, even prior to appointing key advisors. Timing is another key factor in generating a high level of interest and implementing a successful sale. The middle market electronics supply chain is diverse, not least because the key individuals will range from successful family business owners looking to retire, to highly driven, ambitious entrepreneurs seeking the next challenge, to private equity investors looking to realize value from an investment.