Middle Market M&A

Handbook for Investment Banking and Business Consulting

by Kenneth H. Marks, Robert T. Slee, Christian W. Blees and Michael R. Nall

John Wiley & Sons, Inc. 2012
376 pages

Focus Take-Aways
Leadership & Management Mergers and acquisitions (M&A) among middle-market companies present unique
Strategy challenges in the postrecession economy.
Sales & Marketing
Finance Traditional corporate finance techniques dont necessarily apply in private-market deals.
Human Resources
Middle-market firms range in size from $5 million to $1 billion in annual revenue and
IT, Production & Logistics
account for 40% of US gross domestic product.
Small Business
Economics & Politics Valuing a business is a subjective exercise that is part art and part science.
Industries
Global Business Every business has a range of values, depending on its structure, size and intentions.
Career & Self-Development
Four types of buyers individual, financial, strategic and value investors each
Concepts & Trends
ascribe their own perceptions of value to a target.

M&A advisers analyze the authentic financial and operating situation of a target firm.

Successful integration requires a tactical plan that includes managing soft issues.

A global M&A deal requires cultural understanding and a wider view of the transaction.

M&A professionals must follow high standards of ethics and apply strict due diligence.

Rating (10 is best)

Overall Applicability Innovation Style
7 8 7 7

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Much of what is
taught in traditional
corporate finance is
not easily applied,
nor appropriate to
apply, to the private
capital markets and
to many middle-
market deals.
Keep in mind that
valuing a business
is a blend of art
and science, with a
reasonable level of
subjectivity.
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Relevance
What You Will Learn
In this summary, you will learn:r1) How middle-market M&A transactions in the private
market differ from public market M&A transactions, 2) How buy-side and sell-side
advisers handle valuations, and 3) How to lead successful corporate integrations.
Recommendation
A dream team of experts Kenneth H. Marks, Robert T. Slee, Christian W. Blees and
Michael R. Nall brings you this modern guide to mergers and acquisitions (M&A) in
the middle market. It covers a surprising amount of ground, including down-in-the-weeds
topics like tax structures and due diligence as well as complex issues of valuation, all
presented in an engaging but not oversimplified manner. The most impressive aspect of
the book, and the one likely to set it apart from similar works, is its discussion of the
soft issues, the human aspects of M&A in which consultants should tread carefully. For
the most part, the writing moves along with helpful, direct bulleted lists. Instead of the
academic brain dump it could have been, this is actually a thoughtful attempt at helping
advisers help others. Since the text occasionally bogs down in detail that may go beyond
the needs of more casual readers, getAbstract recommends it to M&A practitioners in all
career phases or to businesspeople who want to buy, sell or merge.
Summary
Postrecession Mergers and Acquisitions
Before 2008, those who wanted to buy, sell or merge midsize businesses operated
in a different world than todays precarious environment. Back then, unlimited and
accessible financing flowed to all kinds of companies, almost without regard to their
creditworthiness or underlying operations, to fund all sorts of endeavors. The results
were overfinanced, overvalued businesses that struggled to make the returns needed
in such an overheated market. However, average businesses today find it difficult to
attract any interest from buyers, while top performers realize greater values than they
did before 2008. However, executing M&A activity is much more difficult than it was
prerecession. Advisers need more focused, in-depth knowledge than ever to navigate
rigorous underwriting demands and complex global markets.
Even though the field of M&A has become more stringent, the amount of middle-market
deals for companies with between $5 million and $1 billion in annual revenue is on the
rise: Increasing numbers of private equity investors and baby boomer owners looking to
cash out of their businesses augur increased activity. Mergers and acquisitions still offer
organizations on both sides of a deal growth or liquidity opportunities that neither one
would have without the other. M&A professionals guide both parties through complex
evaluation and negotiation. After the deal, the adviser helps the acquirer integrate the legal
and financial structures, operations, information technology infrastructure, and culture of
the new organization.
The Complex Middle Market
Middle market is a bucket term that describes the three segments of US firms
responsible for about 40% of US gross domestic product. The lower-middle market
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Without a current
valuation, it can
be very difficult
to know what a
business is worth,
and attempting
to transfer a
business without this
knowledge is usually
an exasperating
and frustrating
experience.
The range of
possible values for
a business interest
at any point in time
varies widely based
on which world one
is operating within.
An interest may
be worth nearly
nothing in one world
while its value could
be tremendous in
another. Starting
off in the correct
world is vital to
understanding the
value proposition.
In an ideal
scenario, an
acquisition is the
result of choosing
the best alternative
to accomplish a
strategic objective or
fill a gap.
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consists of companies with annual sales of between $5 million and $150 million. Owner
management, virtually unlimited liability and changeable valuations year to year
characterize these businesses. An owner typically has a significant portion of his or her
personal net worth invested in the business, which doesnt usually pass from generation
to generation.
Middle-middle market firms have yearly revenues greater than $150 million but less
than $500 million. These companies get attention from regional investment bankers and
top lenders because they can usually prove greater efficiencies and maturity than lower-
middle market organizations.
The upper-middle market boasts businesses with annual sales between $500 million
and $1 billion. These companies have the same access to capital and lenders that many
larger corporations have, and they tend to be publicly held.
M&A transactions in private capital markets differ from those in public markets. Unlike
in publicly traded companies, private firms cant rely on objective criteria for determining
their value. In addition, owners and managers of middle-market firms tend to view risk
versus return through the prisms of financial, behavioral and psychological elements.
As a result, M&A practitioners segment their buyers and sellers according to various
characteristics, such as opportunity for return, access to capital, cost of capital, seller
motivation, valuation techniques and transaction costs.
The Process
When representing potential sellers of companies, sell-side M&A advisers execute
a rigorous series of steps: They collect data, research the industry, create or evaluate
marketing materials, negotiate price, structure transactions, evaluate offers, perform due
diligence, negotiate agreements, and close the deal.
Buy-side M&A advisers must understand their clients objectives, help them set their
acquisition strategy, determine the type and size of the target that makes sense for their
clients, and collaborate on the valuation approach they will use.
Placing a valuation on a target business is one of the areas in which advisers find major
differences between public and private markets. For instance, midsize corporations are
inclined to think their company has only one, static value, when, in fact, a firms value
falls into a range, depending on, among numerous other factors, the parties motivations
to buy or sell. Four different types of buyers each ascribe their own perceptions of value
to a target:
1. Individual These buyers want to secure a source of income when they purchase
a new business.
2. Financial A targets economic possibilities attract buyers such as private equity
groups, who are not necessarily involved in the targets industry.
3. Strategic Corporations that want to fill a functional gap or add to their own
strengths will acquire other companies.
4. Value investors These specialists acquire firms that are in trouble and work on
turning them around.
Valuing a business is a subjective exercise that is part art and part science. M&A
advisers have to try to balance risks and potential returns while examining the different
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Without proper
integration, the
performance of the
combined company
will not justify the
purchase price and
sometimes will even
destroy shareholder
value.
Acquiring or
merging with a
foreign company
requires due
diligence that
extends way beyond
financial numbers
and reaching
agreeable terms.
The skills required
to negotiate
successfully in your
own country do not
necessarily translate
to success abroad.
Cultural awareness
is no longer a nice
skill to have; its
essential for success
overseas.
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versions of a target organizations value. An enterprise can have different values at the
same time:
Market value The top value of an organization in the open market.
Fair market value The value of a firm from a tax and legal perspective.
Fair value The value of an entity adjudged in a dispute on asset distribution.
Incremental business value The extra value generated above a minimum
expected rate of return.
Investment value The value of a target to an investors business portfolio.
Owner value The value of a business to its current proprietor.
Collateral value The amount a bank will lend against the targets assets.
Book value The value of a target according to its financial statements.
Successful Integration
Successful integration of an acquired firm requires an early tactical plan that includes
managing soft issues such as cultural change. Without thoughtful and careful
integration, an investor not only risks diminishing the intended value of the deal but
also risks facing severe consequences, such as losing customers or crucial employees,
stunting growth, damaging the brand, and earning less profit. Early in the process, senior
managers should communicate the rationale and value of the deal to employees, partners
and customers. Creating a separate postmerger integration team that is authorized to make
decisions quickly can aid a smooth transition. Additionally, senior managers should watch
vigilantly for signs of declining profits in the core business and work to eliminate M&A-
related distractions.
Mergers involve difficult and complex changes for everyone involved. Identify staff
members who play a critical role and proactively work to keep them with the new
organization. Show employees an immediate improvement in as many areas as possible,
including benefits, compensation, training and working conditions.
A Panoramic Lens for Global M&A
Global M&A requires a different skill set and a wider view of the transaction. When
foreign deals go bad, the fault usually lies in an ignorance of cultural practices rather
than a financial disagreement. M&A professionals must pay attention to cultural due
diligence with the same fervor as they do legal due diligence. Global M&A provides
distinct benefits to buyers, such as the ability to acquire a functional business in a
different geography with an intact, in-place workforce, marketing programs, contacts
and customers. These benefits can help an investor get started quickly in a new market.
However, the M&A team must be fluent in the target culture and must apply a great deal
of emotional intelligence to their approach.
M&A advisers must realize that no matter how successful theyve been in the past, their
skills may not translate to business in another culture. Americans especially should take
note: Whereas US businesspeople use negotiations as a way to come to agreement or
resolve differences, other cultures handle negotiations within a subtext of relationship
building. Americans tend to get down to the technical details of negotiations quickly, but
that can offend and alienate international prospects. A successful global M&A team is
humble and eager to learn about new cultures.
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 Ethics and Due Diligence

Unlike larger organizations that can raise capital in public markets, smaller private
businesses dont have that option and therefore rely on their M&A advisers to represent
Even the best
financial and them ethically. M&A practitioners should strive to stay current in their field, communicate
legal due diligence objectively, create clear reports, develop honest and sincere relationships with clients,
practices do not
uncover the whole
keep confidential matters protected, and steer clear of illegal activity.
story for any given
prospect, and Due diligence reduces risk through thorough research and analysis of a company in
certainly do not
guarantee success.
preparation for a business transaction. M&A advisers focus on the financial records,
tax structure, compliance issues, benefits, employee compensation, and information
technology structure of the target company. Though due diligence wont turn up every

problem in a target organization or a transaction, it will help uncover potential pitfalls in
the deal and ultimately reduce risks for the contracting parties.


The Technical Side


Public corporations have to comply with Generally Accepted Accounting Principles
(GAAP) for financial reporting, but private companies abide by no such rules. An M&A


adviser must conduct a more profound analysis of a private firms financial statements
than would be necessary for a public company. Privately held corporations are motivated
Best practices show to minimize their taxable income, so its not unusual for them to defer income or to pool
that integration
planning needs to private and corporate assets and expenses.
begin early in the
acquisition process, M&A attorneys prepare and guide their clients through transaction paperwork, including
even before due
diligence. confidentiality agreements and letters of intent. Their job is to evaluate the risks and
resolve any technical problems that stand in the way of closing the deal. Because income


taxes resulting from a sale can run as high as 50% of the value of a transaction, M&A
advisers must understand the fundamentals of the various business structures that can


affect the taxable status of a deal. Completely understanding complex tax arrangements
is outside the scope of an M&A practitioners role, so buyers should engage the services
of outsidel tax accountants and tax lawyers when necessary and as soon as feasible in the

M&A process.

Before setting fees, an M&A practitioner should estimate the amount of time required

to get to an agreed-upon outcome with the client. Because buy-side advisers cant be
For acquirers, sure their clients will actually acquire a target, even if it is a perfect candidate, their
closing the
transaction is only
chances of making money through closing a deal differs from those for sell-side advisers,
the beginning of whose clients are usually committed to concluding a transaction. Buy-side agreements
the next chapter
in the life of their
typically require monthly retainers and an extra reward fee for hitting the clients goals.
business. The retainer protects the buy-side adviser from investing time in a deal that never comes
to fruition. Recently, advisers have been exploring co-investment rights: If the deal goes
through, advisers stand to make more money than they would on a retainer. This no-fee
arrangement helps build relationships with clients.

About the Authors

Kenneth H. Marks is founder and managing partner of High Rock Partners, Robert T.
Slee founded MidasNation, Christian W. Blees is president and CEO of BiggsKofford
Certified Public Accountants and BiggsKofford Capital Investment Bank, and Michael
R. Nall established the Alliance of Merger and Acquisition Advisors.
Middle Market M&A getAbstract 2013 5 of 5

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