Commentary & Analysis
Devil in the Details: Issues and Answers in M&As
A successful M&A transaction is the sum of many carefully fashioned parts. This month, New Direction Partners and Margolis Becker delve into the details with comments on how deals can be influenced by client concentration; plant ownership; non-compete agreements with salespeople; acquired management teams; post-acquisition price increases; and personally guaranteed debt.
By Patrick Henry
Published: April 21, 2011
Editor’s note: each month, the partners at New Direction Partners (NDP) join their colleagues at the financial management firm MargolisBecker in a “Cup O Joe”: a conference call with printers on a selected topic of interest. The call’s namesake is MargolisBecker founding partner Joe Becker, whose brainchild the monthly teleforum is.
The Cup O Joe sessions are always lively, and they always generate questions from participants. Here are answers to some recent ones from a call led by NDP’s Peter Schaefer and Stuart Margolis of MargolisBecker.
Eggs, Baskets, and EBITDA
A printing firm may depend on a few accounts - or sometimes just one customer - for the largest share of its business. This kind of concentration, say NDP and MargolisBecker, can be a two-edged sword, especially when negotiating a multiple of EBITDA for sale of the company.
Assume that a seller has one customer from which it derives 30% to 40% of its sales. If the buyer feels that the customer is secure, the multiple could go up. On the other hand, if the buyer suspects that keeping the customer will be risky, then the value will go down. But as long as the seller can demonstrate that the risk is minimal, so will be its impact on EBITDA.
A seller with a large volume of business concentrated in one account should anticipate the buyer’s wish to verify that the relationship is solid.
For example, NDP recently handled the sale of a large-format printing business that owed 80% of its volume to a single apparel manufacturer. This was expected to reduce the multiple. But, as it turned out, the buyer had been wanting to penetrate that account for a long time. The buyer didn‘t view the concentration as a negative, and it was willing to pay more than any other buyer would have because of its desire for that account.
Nevertheless, the deal would not have happened had the seller been unable to convince the buyer of the customer’s loyalty. Sellers concentrated in this way should anticipate the buyer’s wish to meet with the customer in order to verify that the relationship is solid before the deal is closed.
The Owned Plant: Asset or Albatross?
For a seller that owns the plant it operates in, a big question is how ownership of the facility will affect valuation. The answer is that it doesn’t necessarily enter into the equation at all. In an asset-based transaction, the buyer will either acquire the building at market rate or take a long-term lease with the owner (i.e., the seller). If the buyer doesn’t want the building - the likelier scenario when the buyer’s plan is to tuck the seller’s operation into its own facility - then the building will have to be sold, adding a substantial cost for the seller.
But, say NDP and MargolisBecker, there can be creative solutions in situations like this. For example, the firms are representing a highly desirable company that owns the building it occupies. This client wants to be acquired on a tuck-in basis, but it recognizes that selling the building will take time given the current state of the commercial property market. NDP and MargolisBecker have covered the contingency by identifying a buyer willing to pay the costs of maintaining the building for 12 months after closing. The tuck-in transaction was attractive enough to the buyer that it was prepared to take on these costs for a predetermined period of time - a win for both parties.
If You Build It, They Will Come (Maybe)
In any M&A transaction, nothing is more crucial to cement than the loyalty of the seller’s sales force. In cases where some or all of the sales force does not make the transition to the new owner, non-compete agreements can afford a measure of protection against loss of business from the accounts that these salespeople were handling. But, say NDP and MargolisBecker, non-compete protection isn’t as good as persuading everyone on the sales team to come along.
In any M&A transaction, nothing is more crucial to cement than the loyalty of the seller’s sales force.
There is no downside for the owner in obtaining non-compete agreements from salespeople, but non-competes are not absolute guarantees. It’s easier to enforce them in some states than in others, and there are circumstances in which it is nearly impossible to make them stick. Unless salespeople bound by non-competes are being compensated, invoking the agreements can be difficult.
When structuring the transaction, the better approach is to talk with the salespeople about what is happening and why staying on board will be advantageous to them. The buyer should conduct face-to-face meetings with the salespeople early on in the process and get them excited about joining the new company. When steps aren’t taken soon enough to head off defections, having non-compete agreements neither helps nor hurts.
The same kind of thinking applies to the decision that the buyer will have to make about the seller’s management team: should they be kept on, or should they be retired to avoid conflict with the new management structure? If the buyer believes that the seller’s managers are ineffective, then there are grounds for letting them go. On the other hand, if they possess skills that the buyer could use going forward, then their continued participation is a good idea.
The buyer should think about prospect of competition from personnel it chooses to cut loose. In the long run, it may prove wiser to keep them in the fold.
The buyer should also think about prospect of competition from personnel it chooses to cut loose. In the long run, it may prove wiser to keep them in the fold, especially if they have knowledge that differentiates them. Once separated, they can’t be stopped from going elsewhere. They are either going to join the merged company, or (absent agreements to the contrary) they are going to compete with it.
What Were They Thinking?
They’re commonly heard in M&A negotiations: the seller’s misgivings that if the buyer fails to produce the goods in the appropriate amount of time, sales capabilities will diminish, and customers will be lost. Hence the demand from some sellers for a guaranteed minimum payment as a hedge against damage to customer relationships.
Experience shows, however, that picking the right buyer as a partner should eliminate this as a concern. A motivated buyer also will be motivated to please the seller’s customers. Why would any buyer go through an entire negotiation only to let the transaction fall apart because of poor customer care?
Unfortunately, M&A disasters of this kind are not impossible and have taken place. NDP has been called as an expert witness in a case surrounding a tuck-in in which the buyer contractually agreed not to increase prices for 15 months after the deal became final. But, on the day after closing, the buyer increased prices anyway, and all of the customers departed. A lawsuit ensued, and instead of gaining a new base of customers, the buyer ended up losing all of them. It didn’t make sense.
Some sellers demand a guaranteed minimum payment as a hedge against damage to customer relationships. However, picking the right buyer should eliminate this as a concern.
Something else that arises frequently in M&A deliberations is the question of personal guarantees to lenders. Although there is no single answer, the fact is that personal guarantees figure in almost every M&A transaction in the printing industry. This means that before closing, the buyer or the seller must meet with the lending institution to work out a payment plan so that the lender does not have to resort to enforcing the personal guarantee.
For example, a company with assets worth $500,000 and $700,000 in debt might go to its lender and say, “We know you see us as a troubled loan. We can repay $500,000 of the $700,000. Will you accept that?” Or, with $5 million owed on a press, the owner will try to have that figure reduced. There are no guarantees of relief, but in stress situations like these, the lender may be open to requests for debt adjustment.
What can’t be overemphasized is the need to communicate with the lender and learn what the institution is willing to do. If the lender is not willing to do anything, then the next step is to meet with a bankruptcy attorney and ascertain what the lender can do with the personal guarantee. If it is in the name of an individual whose assets are all joint with his or her spouse, the lender may not have much recourse, and the guarantee essentially is worthless. But it’s vital to look into the specifics, or there could be unpleasant surprises.