The objective of this post is to describe, at a high level, the steps in a typical tech M&A project. Each company tends to have their own playbook for M&A deals. Based on my past experience I have summarized the typical process steps in an M&A project. You should talk with people in your company to learn if there is a formal process in place for deals. Typically your company will have already developed an acquisition strategy. Check out this post for more details: How to Build a M&A Strategy. Your firm will also have developed an initial analysis of the target company using publicly available and open source information. For more information check out: Acquisition Candidate Analysis.
The basic process for an acquisition includes the following steps:
|Approach & Initial Meeting
Initial Expression of Interest
Management Team Meetings
Integration & Rollout Planning
Post Rollout Assessment
The process begins with an approach to the targeted company. Typically the senior corporate development executive will approach the target company’s CEO to see if they would be interested in having some discussions. Alternatively, if the company is actively running a sale process an investment banker will contact your company to see if there is an interest in further discussions. In rare cases, investment bankers may contact your firm during a ‘go shop’ period. In these situations, the target company will have already entered into a definitive agreement to be acquired by another firm. To give the target company’s board of directors a fig leaf of cover in performing their fiduciary responsibilities most deals contain a No Shop or a Go Shop period. to seek out competing offers even after it has already received a firm purchase offer. The original offer then functions as a floor for possible better offers. The duration of a go-shop period is usually about one to two months. Go-shop agreements may give the initial bidder the opportunity to match any better offer the company receives, but normally pay the initial bidder a reduced break fee if the target company is purchased by another firm. Historical data has demonstrated that a very small fraction of initial bids are cast aside in favor of new bids during go-shop periods.
Initial meetings typically involve the CEOs of each company and maybe one or two other key executives. The purpose of the meeting is to discuss each company’s business and the potential of a deal between the two companies. Generally, non-public information is not disclosed during these ‘get-to-know-you’ meetings. Often, a range of valuations the target company considers to be appropriate are reviewed. The usual next step at this point is for both companies to execute a mutual non-disclosure agreement.
Before proceeding to a more in depth discussion, sellers will often want potential buyers to submit a formal initial expression of interest. This is a non-binding description of the structure, valuation, timing, and contingencies associated with a potential deal. Sellers only want to engage with buyers that are serious about closing a deal and that the buyer has the resources and approvals to make the deal actually happen.
Once an NDA is signed, the next step is to hold meetings between the two companies’ management teams. Typically the CEO, COO, CFO, VP R&D/Operations, VP Corporate Development, and VP Marketing attend. More or fewer members of the teams attend depending on the circumstances and preferences of the CEOs. The goal of these meetings is for your company to gain enough insight into the target’s business so you will be able to make a firm offer. While your organization may suggest topics that they would like to see covered, typically the target company controls the agenda and presentation. Topics usually include a brief financial statement review, organization chart review, market overview and competitive landscape, product/service overview/demos, sales channel reviews, customer service overview, professional services overview, and a finance and administration overview. Most meetings last one day and maybe be preceded or followed by an informal dinner so the players can get the chance to know each other on a more personal basis.
After the meeting has been completed, each member of your company’s team that participated should write up a brief overview of what they learned and what additional risks and concerns they have about the target company and deal. A formal debriefing session should be held where everyone can share their perspectives.
When ready, the next stage of the process is to submit a term sheet to the target company. A term sheet is usually a formal offer to buy the company. It is expressed as a series of bullet points versus a complete purchase or sale agreement. Term sheets typically cover the structure of the transaction (stock purchase, asset purchase, break up fees, etc.), the consideration or value of the purchase, major milestones, and material terms and conditions (completion of diligence, securing debt financing, typical representations and warranties) etc.
A term sheet is generally a brief document – no more than a few pages. It becomes the foundation for development of comprehensive transaction documents which can run into the hundreds of pages. The parties can negotiate these terms at a high level before incurring the significant expense of having attorneys draft the formal agreements. Most term sheets are contingent upon the satisfactory completion of due diligence. Once the terms have been accepted the rest of the process can get underway.
Due Diligence is the process by which the buying organization conducts a comprehensive investigation of the target company’s finances, legal affairs, and operations. Generally there are three major types of due diligence:
- Financial Due Diligence. This is a comprehensive review of a company’s financial statements, policies and accounting controls. The CFO/VP of Finance leads this process, often times assisted by outside auditors and experts. If the target company has operations outside of the USA additional experts in local geographies may be required as well. Typical activities include review of financial statements, assessing the quality of earnings, federal, state, and local taxes, reviewing past reports from independent auditors, etc.
- Legal Due Diligence. Involves reviews of corporate structure, legal entities, board minutes, past and current litigation, employment agreements, and shareholder agreements. If appropriate debt agreements and compliance with covenants is covered as well.
- Operational Due Diligence. Operational due diligence involves the various functional parts of your organization reviewing their counterparts in the target organization. This includes Marketing, Product Management, Product Marketing, Research & Development, Technical Operations, Customer Services, Sales, Finance & Administration and Human Resources.
The Diligence process typically has five major steps. First, each functional area will develop a diligence information request. This lists the topics, deliverables, reports, and issues each area would like to cover in their diligence activities. Care must be taken not to overburden the target company with requests that take a long time to produce. Usually existing management reports and analyses can satisfy most diligence requests. As the target company assembles responses to the diligence request, the results are often uploaded to an online, secure data room where the appropriate people at both organizations can access the information. The next step involves diligence meetings. In these meetings, each part of the diligence team meets with their counterparts to review the requested diligence information, pose questions, and resolve any open issues. These meetings typically take a couple of days and are often held at offsite locations to minimize the impact of the target company’s operations. After the meetings are completed each diligence team will prepare a formal diligence report that describes the results of their investigations and any remaining open issues or risks. Finally a formal meeting is held to review the diligence reports and make recommendations on whether to proceed or not to proceed with the transaction.
Most diligence investigations find only minor issues or problems. Occasionally, larger issues are found. One deal I was tangentially involved in 1994 was when Sterling Software acquired KnowledgeWare, Inc. During the diligence process Sterling discovered a number of revenue recognition issues associated with channel sales and side letters. Sterling forced KnowledgeWare to restate their financial statements and they established a $15 million escrow account from the sale proceeds to deal with various lawsuits. I was a mid-level manager at the time.
In parallel with the diligence process, the companies will negotiate the formal agreements to effectuate the merger. Two common approaches are a stock purchase agreement or an asset purchase and sale agreement. If both companies are privately held the agreements are simplified somewhat. If one or both companies are publicly held things get a bit more complex.
Stock purchase agreements are the most common. Under this approach, your company purchases all of the outstanding stock of the target company. The consideration may be all cash, a combination of cash and stock, or all stock. To get a feel for the structure and complexity of these documents take a look at the table of contents in this link. It is the definitive agreement for Open Text to acquire EasyLink Services, a company I was a senior executive of (I left well before the merger was made). The agreement is over 75 pages.
In the case where the target is a public company, an additional step is required. The company will have to get approval from its stockholders. This requires a couple of steps. First, a formal proxy statement has to be developed and filed with the SEC. Here is a link to EasyLink’s proxy statement for the deal where it was acquired by Internet Commerce Corporation. I was actively involved in this deal. Once the proxy statement has been filed with the SEC, they review it, and generally approve it. At that point the proxy statement is declared to be effective and the shareholder vote can be scheduled and held.
Asset Purchase Agreements are often used for smaller types of transactions. Generally your company buys specified assets of the target company – intellectual property, customer contracts, employment agreements, international distribution rights, accounts receivable, copyrights, trademarks, patents etc. The buying company specifically does not purchase any liabilities. Asset purchase agreements are usually easier to negotiate, execute, and close. Asset purchase agreements are often used in divestitures when only a portion of a company’s business is being sold to an acquirer.
Some acquisitions require approval from regulators before they can close. In the United States the Hart Scott Rodino act controls regulatory approvals for acquisitions. Under HSR, the acquirer files a notification with the Federal Trade Commission and the Department of Justice. Typically they take 15 to 30 days to approve the transaction or object to it. There are guidelines regarding which transactions are required to file, but generally companies with less than $200 million in stock value are not required to file. In rare cases, the FTC/DOJ will make a second request for information which will extend the evaluation time. In the UK, the Competition and Markets Authority performs a similar regulatory review.
Regulatory reviews typically occur once definitive agreements have been negotiated, but before the deal actually closes. Regulatory reviews typically run in parallel with Integration Planning.
The next step in the process focuses on determining how to integrate the two companies and rollout the integration to employees, customers, partners, industry analysts, and press. There are many different styles of accomplishing this. Some organizations use a boot camp approach where teams from both companies meet in an offsite location to plan the integration/rollout over a compressed period of time. Other approaches spread the process out over weeks/months, meeting part time. The approach is dependent on how the senior leaders of the acquiring company want to drive the process.
Most planning and rollout planning efforts cover the following seven items:
- Concept of Operations
- Organization Chart & Roster Development
- Business Plan Development
- Transition Plan Development
- Separation Planning
- Transition Plan Management
Concept of Operations
Senior management develops a basic concept of operations based on the information learned during management meetings and due diligence. This concept lays out the basic framework for how the merged company will operate. It answers questions like will the acquired company’s business functions be consolidated into the existing organization or will it operate as a separate business unit? Will the company and products be rebranded? Will some products/services be discontinued? The concept of operations provides a foundation which the integration team can use to guide their planning activities.
Organization Chart & Roster Development
One of the first things teams do in Integration Planning is to define to new organizational chart and roster. This is typically a top down process with senior executives being picked first, followed by their direct reports. These individuals are then typically invited into the planning process. Usually senior positions are split between the acquiring company and the acquired company. This process continues on an iterative basis until a determination is made for every employee. Employees are categorized as Keeps (stay with combined organization), Cuts (position eliminated in the combined organization, or Transition (stay with combined organization and transition their responsibilities to other employees and then the position is eliminated).
This is typically the most difficult activity in Integration Planning. Many acquisitions rely on reducing labor costs to achieve pre-established financial targets. It is difficult to decide the fate of co-workers that you have worked with for many years and through no fault of their own find that their position is redundant and will be eliminated. It is vitally important that these decisions be kept confidential until the actual rollout of the acquisition. The time period between when an acquisition is announced and when it closes and rolls out is often called the valley of death. Employees sit around and constantly wonder about their fate. The best integration processes compress this time to as short as possible.
Business Plan Development
The next step in the Integration process is to develop business plans for each organization. Generally this includes defining goals and objectives, strategies to achieve the goals, tactics to implement the strategies, timelines and milestones, and budgets. Risk and risk mitigation plans are also covered. Specific deliverables required to support the rollout of the acquisition are developed as well. Product Managers and Product Marketers are actively involved in these activities. This is typically an iterative process. Each organization develops a portion of their plan, presents it to senior management to obtain feedback and guidance, and then they develop another iteration of their plan. They will also interlock their plans with other affected organizations.
Some deliverables need to be available for the rollout of the acquisition. Examples can include brand updates, website updates, customer communications, product/service roadmaps, sales compensation plans, integrated HR title, compensation, and benefit plans, updates to payment processing procedures, customer service phone line greetings, etc. The list can go on and on.
Transition Plan Development
In addition to the business plan, each organization develops a transition plan. Some integration activities cannot be completed in the timeframe of the integration planning process. Rebranding software products, migrating/consolidating financial systems (GL/AR/AP/Payroll), executing data center consolidations are a few common tasks. Detailed plans need to be developed that describe the tasks, timing, resources, and milestones associated with transitioning to the new organization.
An unpleasant but necessary task is to plan for the separation of employees whose positions were eliminated as part of the integration. The terminations affect both employees of the acquired company, but the acquiring company as well. As part of organization chart and roster development, certain employees will be identified for termination. It is important to stress that these terminations are not a result of poor job performance, but a function of designing a new more effective organization.
Depending on the number of terminations, the acquiring company may have to comply with the terms of the WARN Act (Worker Adjustment and Retraining Act). The WARN Act generally requires 60days notice of a mass layoff or the equivalent minimum payment in severance. Employees in EU countries also have specific rights as well in the case of what is known as collective redundancies.
One example from my career involved 75 consultants in Italy that were working at very low rates for a major client. The revenue the consultants generated was immaterial to the company’s total revenues. In the company at the time we preferred to have consulting services primarily delivered by partners versus our own staff. If we decided to layoff the consultants, under Italian law it would have cost us almost as much as we paid for the entire company. Instead we struck a strategic relationship with a partner and they hired all of the consultants and committed to a large purchase of the company’s products for resale. It was a win for all parties involved.
Separation planning involves developing a severance policy, preparing severance packages (pay, continuation of benefits, outplacement services), identifying the managers who will make the employee notifications, training the managers, and developing a timeline for conducting the notifications. Employees are typically terminated the day the acquisition formally closes and rolls out.
Closing is the formal legal process of completing the acquisition. Depending on the situation this can include the execution of definitive agreements, conducting a shareholder meeting and proxy vote, notification of appropriate governmental agencies/stock exchanges, and the disbursement of funds. This step is generally not held in public.
Concurrent with the closing the acquisition is rolled out to employees, shareholders, customers, partners, industry analysts, and press. Generally all hands employee meetings are held after notifications to terminated employees are conducted. Individual organization and tea meetings are often help after the general all hands meeting. Press releases are issued and industry analysts are briefed. Sometimes analysts are briefed before the rollout on an embargo basis – they agree not to publish anything until the public rollout date.
Post Rollout Assessment
60 to 90 days after the completion of the acquisition a post rollout assessment is held. The goal of this assessment is to identify what worked, what did not work, and how the process can be improved for the next acquisition. There is an old saying that “No battle plan survives the first contact with the enemy”. The same is true for acquisitions. Detailed planning and experience can help, but there are so many moving parts in an acquisition that there are always opportunities to improve.