The Role of Financial Advisers in Merger and Acquisitions
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As further explained in the introduction of this guide, M&A transactions can take many forms or structures. Among others, companies may seek to merge operating businesses, acquire companies or assets, engage in an auction process to find a suitable buyer, enter into bilateral negotiations for the purchase and sale of the business or seek joint ventures to combine forces while preserving their corporate structures. The role of financial advisers in each type of M&A transaction may vary but there are some common topics that characterise the adviser’s role. This chapter will focus on a sale process of a private company through a competitive auction, in which the financial adviser is representing the sellers. We selected this example as it is typically where the role of the financial adviser is predominant, which helps illustrate critical points applicable to all processes.
When it comes to buying or selling valuable assets – be it real estate, a piece of art or a vintage car – many owners and investors rely on experts. Generally, from a seller’s perspective, these experts mainly focus on maximising the specific asset’s value, usually by designing a sale process that seeks competition from a wide array of potential buyers all competing simultaneously, as, for example, in the case of the sale of a painting via a reputable auction house or a bidding war created by a realtor over an apartment. The main difference, however, between auctions designed to sell valuable assets and the process of selling a company through an M&A process is that determining the appropriate valuation is a more complex process that requires spending time and money to understand the details of such business. Among other things, a business is a going concern that evolves with the passage of time and accumulates assets, liabilities, opportunities and risks that impact its valuation. Considering this, the fundamental role of a financial adviser in the sale of a company is to design and run a sale process that maximises value for the company’s shareholders and minimises the burden imposed on management by multiple buyers trying to understand the ins and outs of the business.
Running a simple auction for a private company the way it is done with a Picasso painting would be inefficient as buyers that do not have enough time to understand the details of a business will never be willing to pay top dollar, as they will inevitably price in the uncertainty of any unknown issues that could materially reduce the value of the asset. For a buyer to adequately price a business it must understand its capacity to create value (either through its cash flow-generating capabilities, by identifying synergies with another existing business or by creating business opportunities not otherwise available, like entering into a growth market). It must also grasp and measure the business liabilities and risks to be considered and subtracted from the purchase price to make sure the value-generating capabilities are effectively offset by the value-hindering liabilities. It is the seller’s financial adviser’s responsibility to make sure that all the value-generating capabilities are uncovered, highlighted and marketed to buyers, as well as to provide information on the value-hindering obligations so buyers have all the information they need to appropriately evaluate the opportunity. An experienced M&A financial adviser on the sell-side should be able to design and run a process that gives just the right amount of time to the most likely potential buyers to analyse and understand a business, while at the same time sustaining the momentum and pressure created by an auction in seeking the highest possible price from buyers.
The cornerstone of a well-designed sale process and a substantial portion of the value a financial adviser brings to the table takes place in the preparation phase, long before any potential buyers are contacted. During this phase, the adviser gets to know the business in detail, identifies and addresses potential transaction issues, clearly defines the set of buyers to be contacted and the approach tactics to be used, prepares the marketing materials and designs a sale process with specific timing milestones.
The first step in the preparation phase is for the financial adviser to get to know and understand the business in detail and proactively identify key issues and risks and their respective mitigants. A good financial adviser should spend the necessary time before launching a sale process analysing and scrutinising the business to be sold. Only through this dedicated time and effort will the financial adviser be able to identify, promote and emphasise the investment highlights of the company that will ultimately attract the interest of buyers, and support the expected valuation. Additionally, this preliminary due diligence will also enable the adviser to be prepared to answer accurately the many questions and inquiries buyers will have throughout the process, thereby minimising the burden on management and adding certainty to the process.
While performing this business due diligence, the financial adviser should also take the time to engage with management and shareholders and anticipate answers to some predictable but critical questions around the strategic rationale of the transaction that will surely arise from some buyers: ‘If the company is performing so well, why are you selling now?’; ‘Will you be willing to stay on as a minority partner for some more years?’; ‘Will you be willing to continue working for the company after you’ve sold it?’, as well as questions around the company’s historic performance and legal standing that will arise during diligence. In addition to having the right answers to business and strategic questions – which will only enhance the value of the business – a financial adviser should also anticipate potential legal, regulatory and contractual matters and risks that could impact the sale, its timing and the price buyers are willing to pay. These are typically identified and assessed in close collaboration with legal counsel. The most typical issues in this area include antitrust approvals (depending on the identity and business of the buyer), labour, environmental and other regulatory concerns or specific industry approvals that may be required. If a financial adviser does not anticipate these types of hurdles before launching a process and more importantly, does not implement mitigating potential solutions, that adviser would be forced to improvise by tackling these impediments in real time. Improvisation is one of the worst enemies of getting a deal done – so it should be the adviser’s role to foresee and address the potential obstructions before they appear, so all the parties involved are prepared and have a plan to confront the particular challenges.
All the knowledge obtained during the financial adviser’s due diligence will be the foundation for the preparation of the marketing materials required for the sale process. The fundamental objective of these materials is to generate interest from potential buyers by highlighting the attractiveness and uniqueness of the investment opportunity, but it is also important that the materials be sufficiently comprehensive for a purchaser to estimate the price it is willing to pay for the company. These materials usually consist of a very brief teaser used to gauge preliminary interest from buyers and then, after confidentiality agreements are signed with those who want to further analyse the opportunity, an information memorandum including a detailed description of the business, usually centred on the operational and financial aspects of the business that is made available. These marketing materials usually include detailed financial projections used by buyers to understand the business’s cash flow generation capabilities, which in turn will serve as the base for the valuation analysis that will determine the price they are ultimately willing to pay to purchase the company. The financial advisers will work with counsel to ensure that the marketing materials do not give rise to obligations of the sellers, unless and until binding negotiated agreements have been signed.
In parallel, the adviser also prepares, usually in coordination with management and the shareholders, a list of potential buyers to be contacted during the process. To select the right list of buyers it is important to consider the size of the transaction, the structure of the deal (e.g., minority versus sale of control, which may impact the preference for a strategic buyer versus a private equity or similar investor), the industry dynamics and a buyer’s ability to pay. Just as important as identifying potential interested parties is coming up with a strategy to approach each buyer, including how to position the story and who is the right person inside an organisation to be contacted. On this particular topic, the experience and track record of the financial adviser is key, as many processes fail to engage some potential buyers because the wrong person was contacted or because the adviser did not have the ability to reach the right executive or decision-maker. An adviser’s experience in the industry and region where it operates will assure that the opportunity reaches the right individuals – those who will make sure it is thoroughly analysed and pushed within the potential buyer’s organisation and hierarchy. The advisers’ track record will also ensure such individuals give full credibility to the process and the opportunity.
The final step of the preparation phase, before officially contacting buyers, is to design the sale process per se. Processes can range from having only one or a few selected parties contacted, to a broad auction process where multiple buyers are approached. Selecting the right type of process will depend on the objectives of the selling shareholders, the views on how broad the buyer universe is, as well as current market and industry dynamics. The decision between a targeted versus a broad auction process involves a trade-off between confidentiality, duration and competitiveness. Usually, when it comes to maximising value, competition (or the appearance of it) is absolutely necessary. Every company has a theoretical value that can be estimated using relatively standard valuation techniques (a discounted cash flow being the most common). Regardless of the value, a sale process reveals what the market is willing to pay for a particular asset or company – its price. A well-designed sale process should seek to obtain the price the market is willing to pay and, in certain occasions, to surpass the theoretical valuation of the company. It is usually through competitive tension that this result is obtained.
Once the preparation stage is over, the sale process begins with the initial approach to buyers. At this point, a typical auction usually involves two phases. During the first phase, once potential buyers express interest in learning about the opportunity, detailed information (including the marketing materials and business plan) is shared with those buyers willing to execute confidentiality agreements. Buyers are then usually given a certain amount of time to analyse the materials and, if interested, to send a non-binding offer indicating the purchase price they would be prepared to offer for the company. These preliminary or non-binding offers give the target’s shareholders an indication of the price range buyers are willing to transact and enables shareholders to narrow down the number of prospective buyers to invite to the second phase. During the second phase, buyers still participating in the process are provided access to information, usually through a virtual data room, required to complete due diligence as well as access to management and site visits.
The advantage of structuring the sale process in two phases is that it enables sellers to evaluate preliminary offers and narrow the list of buyers based on the initial indications of interest without a significant level of interaction and having shared a limited amount of information. Once a selected group of buyers gets invited to participate in the second phase (also known as the due diligence phase), buyers will have the chance to interact with management and sometimes shareholders. Sellers then have more confidence that they are sharing detailed information and interacting and spending valuable time with potential buyers that have expressed interest, therefore concentrating their efforts only on buyers who have expressed a credible willingness (subject to due diligence, of course) to purchase the company at an attractive price and are interested enough to invest some time and money further pursuing the opportunity.
This second phase of the process, involving these pre-selected buyers, centres on facilitating due diligence. Here, the financial adviser plays a key role as he or she designs, organises and oversees three aspects of a typical due diligence process. First, buyers have the opportunity to meet and interact with management. This is usually set up as a formal presentation with each potential buyer where key members of the management team get to present the company. This meeting evolves into a Q&A session with each buyer that is seeking to understand details of the business that may impact valuation or other terms. All the materials used in this presentation as well as all the logistics involved in organising numerous meetings with each potential buyer are led by the financial adviser, including thoroughly preparing management for the process. Second, buyers are usually invited to visit the seller’s key facilities. The logistics as well as the design of the visit protocols and rules is led and steered by the financial adviser. Third and finally, the due diligence process gives access to all the relevant seller documentation a buyer needs to review and analyse through a virtual data room. For a data room to be useful and fulfil its purpose, it has to be comprehensive and include any relevant and material documents that would enable a buyer to understand, analyse and verify that all the information communicated throughout the marketing materials was accurate. During the process, the financial advisers also closely cooperate with counsel, including to ensure the protection of commercially sensitive information from competitors that may be involved in the process, avoiding breaching regulatory restrictions on information sharing among competitors, and to identify third parties that may have consent rights on the transaction or on the sharing of information.
Approaching the end of the due diligence process, the financial adviser will ask potential buyers still participating in the process to present final offers. As opposed to the preliminary non-binding offers, in this case offers are expected to include buyer’s comments to a draft purchase agreement (PA), and if applicable, a shareholders agreement (SHA), in each case, prepared by the seller’s legal advisers, which will detail all terms and conditions (in addition to price) for the proposed transaction. If the process has been successful in its objectives and the asset has attracted enough buyers, the financial adviser should be able to create competitive tension among potential buyers with a clear and defined timing throughout the process to ensure buyers are able to submit a definitive offer at the same time and by providing the same level of due diligence information and access to management to ensure the offers submitted are comparable.
In a situation where this is achieved, the seller will be faced with the decision of whom to sell the company to. Although on some occasions this is a very straightforward decision (value differentiation is usually the predominant driver in selecting the winning offer), in most cases this decision requires further considerations. One of the key roles of an M&A financial adviser is to help sellers evaluate all the components of the different proposals from potential buyers, beyond just the purchase price. Things to consider besides value include, among others, the ability of a buyer to pay (including ability to secure financing), key terms suggested in the PA (and SHA, if applicable), any antitrust considerations or other regulatory or third-party approvals required, future plans for the company and for the employees, and in cases where there is stock consideration in the purchase price, valuation thereof as well as the future growth potential and performance of the combined entity.
This is not always a straightforward process as various questions usually arise when considering these factors and the way they could impact a potential transaction: How do you qualify and quantify them? Which could have the most material impact? How do you compare them among bidders? Responding these questions is where both legal and financial M&A advisers’ previous experience and knowledge are most relevant for sellers, as at this point M&A becomes more of an art than a science. Also relevant at this point is the interaction the financial adviser has had with potential buyers during the process. As described earlier, sale processes are usually designed in a way that provides multiple points of interaction between potential buyers, M&A advisers and sellers. These interactions allow advisers to gather information and assess the level of interest of a particular buyer, the amount of work done through diligence (and money spent), the relationship with the existing management team or shareholders throughout the process, their ability to pay or finance a deal by understanding the buyers’ financial capabilities and their track record in consummating similar transactions. All of these points of contact and relevant information will influence or at any rate impact the seller’s decision on which offer to accept.
The final stage of the sale process is the negotiation phase, which, in the best case scenario, can be entered with more than one buyer. At this stage, both legal and financial advisers engage directly with the buyers and their respective advisers to try to agree on price and the open terms of the contract. Maintaining competitiveness at this stage is challenging (you may have to produce alternate schedules for the bidders or duplicative teams and closely monitor the daily progress with each potential buyer), but ideally a negotiation can be performed with a couple of buyers in parallel. If this competitiveness is achieved, financial advisers will create a dynamic in which buyers are more willing to make concessions or accommodate sellers’ requests to become the winning party.
The vast majority of the items to negotiate at this stage revolve around the open legal terms in the PA (and, if applicable, the SHA). The PA includes business as well as legal terms that require both the active participation of the financial and legal advisers. For example, some key open business items are frequently the purchase price adjustments and the definitive deal structure (e.g., percentage equity to be sold, future options to sell the remaining equity, earn-outs, among others). At the end of the day, both advisers (financial and legal) will try to determine the amount of risk that a seller will be exposed to by signing the PA, both between signing and closing of the transaction and particularly after closing. These risks can have a direct economic impact on the seller as they may represent purchase price adjustments (that can be in favour or against the seller) and future indemnifications. They may also impact closing certainty. In comparing and evaluating proposals received from potential buyers, it is of uttermost importance to quantify the potential impact of the proposed legal terms. At this stage, it is the financial and legal M&A advisers role to assess and recommend to the seller’s board or shareholders a path forward based on the outcome of the process and the thorough analysis of all the offers received.
Furthermore, in M&A transactions that involve a merger between two parties, an acquisition with stock consideration or a partial acquisition (not 100 per cent of equity), in which the parties involved remain as shareholders of the existing or combined company, issues around governance become an important part of the negotiation. Negotiations around governance are usually documented in a SHA and typically include, among other things: board of directors’ composition and representation, appointment of key management roles (i.e., CEO, CFO), transfer of shares and liquidity alternatives, budget and business plan approvals, or supermajority or veto rights for key decisions. Having the right set of governance terms in place allows a seller to protect its existing interest in the company and maximise value at the time of a future sale of its remaining interest. Both financial and legal M&A advisers will lead the negotiations of the key terms in the SHA. For financial advisers, maintaining multiple buyers interested at this stage of the process is absolutely vital as a negotiation tactic and is usually crucial to achieve a successful outcome for clients.
While the role of a financial adviser in an M&A sell side process described throughout this section is based on a typical sale auction process commonly used when selling a company, many M&A deals get done through processes that for different reasons differ from what we have laid out here. One of the most relevant pieces of advice a client will get from its financial advisers is precisely how to tailor a sale process to attend to the specific shareholders’ objectives, the universe of potential buyers, the timing to get a deal done, among other decisive factors where the advisers bring their expertise to the table to provide unique context and tailored advice to every client.
 Nicolas Camacho is a managing director in the M&A team at Credit Suisse.The information in this chapter was accurate as at December 2020.
 While not addressed in detail in this chapter, financial advisers representing buyers in such type of process will be focused on negotiating appropriate valuation from their clients’ perspective and guiding them through the process in a manner that maximises the opportunity to win the asset within the price range and risk appetite of their client.
 See Chapter 14 of this guide, ‘Preliminary Legal Documents in M&A Transactions’.
 Other valuation techniques commonly used when valuing companies include relative valuation based on comparable public companies trading multiples and comparable precedent transactions multiples.
 For transactions with all or part of the consideration payable in stock of the buyer or its affiliates, the role of the investment banker is significantly enhanced, including to ensure that the valuation of the issuer is appropriately measured against the valuation of the target. That includes a significant reverse due diligence exercise (unless the issuer is publicly traded).