Six years after the dotcom bubble burst and M & A; activity came to a virtual standstill, acquisition fever seems once again to be raging through corporate America. Worldwide, merger and acquisition deals totaled $2.5 trillion in the first nine months of the year, close to the total for all of 2005, according to Thomson Financial, promising that, when all is in and accounted for, this year could see a 50 percent hike in transactions over 2004. And it isn’t just the largest players that are getting action. Firms as small as $5 million are being courted, and just as likely by international suitors as by local ones, often because they have a technology or a niche that will help a much larger player get bigger yet. The Business Journal convened a panel to find out just what buyers, sellers and those who work with them can expect should they venture into the fray. Our panel included: Michael E. Adler, president and managing director of Calabasas-based Informa Research Services Inc., a division of T & F; Informa plc that provides competitive intelligence reporting and services and has acquired three companies since 2003; Peter Cowen, a former co-founder of Data Voice Solutions Inc., now managing partner at Spire Equity, a private equity firm in Camarillo, who has advised over 200 emerging growth companies and helped to raise over $100 million for early-stage businesses; Gordon Gregory, chairman and managing director of Encino-based Mosaic Capital LLC, an investment banking firm and member of the International Network of M & A; Partners that specializes in the middle market and has transacted five deals in the past year; John O. Johnson, founder and managing director of The Spartan Group LLC, a boutique investment banking firm in Glendale focused on public and private middle-market companies that has this year assisted in three transactions on both the buy and sell sides along with venture financing for a film production company headed by Tom Pollock and Ivan Reitman; and attorney Brent A. Reinke, a corporate partner at Musick, Peeler & Garrett in Westlake Village who focusing on mergers and acquisitions, venture capital, advising emerging growth companies, corporate securities and finance, strategic alliances and licensing. From the spirited discussion, it became clear that while there are many opportunities out there, both for those who want to grow by acquisition and those seeking exit strategies, there is also much potential for failure in what has become a frenzy of activity. Question: What is the current environment like for M & A;? Johnson: It certainly is a seller’s market. We saw a deal where we’re actually working on the buy side (unfortunately) for a client where the seller in a particular geographic market said if you want to bid on this and get into the second round, you have to sign a two year non-compete. And when we go to final bids, we rarely take one bidder now. We normally take two and say, mark up the purchase and sale agreement and we’ll use this as the basis of differentiating one and two in the bid process. Adler: Most of the companies we’re buying are companies that were founded 10 or 15 years ago and they are looking for an exit strategy to cash out. The problem we run into is that everybody thinks it’s a seller’s market and some of these companies where they’re really not worth anything, they’re making $100,000 a year and they want $100 million for their company. They’re not being realistic anymore. Cowen: It is a seller’s market. Because it is a seller’s market, people are more delusional. It isn’t quite the irrational exuberance of the dotcom bust. But companies that have innovation and a few customers are getting a lot of attention. And venture funds and even some private equity funds that have found that there’s too much competition at the higher levels are coming to younger companies, boosting up the premium and getting more involved with them. Question: What are some of the biggest mistakes people make when they go out into the market to buy companies or to sell their companies? Adler: A lot of times what we run into is that the owners who are selling have one set of goals but they wind up in this auction process. We’ll look at it and say, ‘okay you want to stay on board, we’re with you, that’s how we’re going to buy it. The company that we may lose out to makes the same promise, but in three months (the former executives) are gone. The next thing they know the whole company has been decimated because it was more of a revenue acquisition. So I think some of these people are trying to get the best of both worlds. They want the most money, but they also want security and everything else. But they don’t realize they haven’t negotiated the right deal, and the next thing they know they have a two year contract and the buyer will just buy it out and they’re gone. Reinke: Especially in the market we’re dealing with now, because there’s so much pressure to get deals done quickly, (what’s important is) really understanding what the company is going to look like and how it’s going to operate post acquisition and whether the synergy is there at the management level. Is integration going to work smoothly? Are you going to obtain value? I’m talking more from a strategic acquisition as opposed to equity. Are you really going to reap the value you think you’re getting out of this acquisition post closing? There’s a lack of due diligence, and I think that’s part of the fallout of the pressure to get deals done. They’re taking on greater risk, not only financial, but because you’re cutting down on reps and warranties, you’re dealing with the indemnity provisions and you’re paying more. And they’re not taking the time to really do the due diligence. Johnson: Statistically, at least 60 percent to 70 percent of acquisitions fail to achieve their objectives. It’s not just quantity of due diligence. It’s cultural due diligence. Do you have a common vision and strategy going forward? Do you have aligned interests? If it’s two companies coming together, is there an integration that makes sense from both a vision/strategy perspective as well as making sure everyone’s interests are aligned? Too often people don’t deal with the tough issues, like they’ll have co-heads. Co- heads never work. You’ve got to have somebody that’s the primary leader in any organization, and a team that’s able to execute on that vision and strategy with that leader. Adler: As advisors, do they really care what is a better cultural fit? Or do they care about getting the deal done? Gregory: Our job is to find out what really matters to our clients. It takes a lot of head shrinking to find out what really matters. Johnson: You do raise an interesting point Michael. How does a seller know when they’re interviewing bankers which ones are going to be more scrupulous? To some degree you have to do your own due diligence. You have to talk with some of the other people they’ve worked with in the past. You have to ask what is the history with that firm? I truly believe the karma thing that what goes around comes around. If you stuff a bad buyer down somebody for the best price something is going to come around and you’re going to have to live with that. And there are some very credible people and in a shifting environment, a lot of people who are not. Cowen: A lot of trusted advisors let their client know what the tradeoffs are. Sometimes a few extra million dollars makes a difference. Sometimes it seems like a huge mistake versus the long term consequences. In our world, when we have a whole group of investors that might want to invest in a deal it’s much closer to a marriage than maybe some of the equity deals. We’re talking about somebody who’s going to be your partner, who has certain power to hire and fire you on the board and they’re also giving you enough rocket fuel to accelerate what you’re doing. So things are going to be a little more unwieldy. How do you handle that? How do they handle that? And the thing I see is that at least in my world venture capitalists and angel investors and high growth investors, on certain deals they’re good and certain deals they’re not. Question: What can buyers and sellers do to make sure the acquisition will integrate well and meet their desired goals? Adler: It’s better due diligence, but you’ve got this pressure of bidding wars going on, and if you don’t strike quickly then you can lose it to the next guy. When we were purchased the first time they spent about four hours doing due diligence on us. And there was a lot of buyer’s and seller’s remorse because what they bought and what they got were two completely different things. They bought us thinking we’re cheap and they thought they were buying a client list but it turned out that who they sold to and who we sold to were two completely different things. After they closed the deal and they realized we had no value to them they just let us meander. And it wasn’t until we wound up selling ourselves to the London based company that we were truly able to take off and prosper. Gregory: One of the difficulties is a seller does not know how to package itself. They do not know how to put the whole story together. They do not know what is required to be ready, ready from the standpoint of being able to do a transaction and what steps they can take to be more valuable. And apart from that, you have the whole transaction process and that absorbs an enormous amount of time and attention so if they try to do it themselves they will not have time to run the business. Johnson: A common misperception by most sellers is they think the value of the banker is in finding the buyer set. I would argue that’s the least value. That’s not entirely true. We do charge for that. It’s positioning the company. It’s getting it ready, not only for a sale but for the due diligence process. It’s managing the process; it’s negotiating; it’s working with a law firm. It’s doing a number of things that have nothing to do with the set of buyers per se or any individual buyer. What we do is get the company ready whether they want to arrange financing, whether they want an exit, whether they want to take chips off the table. Ready is ready. Gregory: We did a transaction a number of years ago of an engineering-manufacturing company. We sold it to a competitor on the East Coast, and the seller was as difficult a human being as there is to be found anywhere. On the day of close they asked him to be packed and out that day. The general manager of the division that was going to be absorbing it was instructed to be prepared to step in and run it as if this guy is gone. Otherwise they would not let him buy it. Johnson: That’s the key. You have to act quickly and you have to act decisively. It points to a couple of different red flags in the industry. If you’re paying high prices, if your due diligence is being stifled or hastened because of a competitive process, unless you’re prepared to go in and analyze not just the numbers but more importantly some of the strategic and cultural aspects, there’s a higher risk of failure. Question: Are there potential problems that are likely to arise down the road from all this easy money chasing acquisitions? Cowen: The market is on a full head of steam, the economy is doing very well, and I think the lenders are becoming halcyonic. They’re over-extending themselves. Their risk return ratio is out of whack. Because of that, a lot of these deals look better than they should. If there’s a glitch and a slowdown and some of the sales slow down and the debt is heavily leveraged as it is, then there’s promise for recalls. There’s promise that the debt market slows down and a lot of that cascades. I think we’re in that situation. Johnson: I think what is different now versus 1999 is the OCC (Office of the Comptroller of the Currency) doesn’t have much impact because these debt providers aren’t banks anymore. They’re hedge funds, they’re mezzanine funds. They’re special purpose funds. It’s there where I think we’re going to have the problem. It’s going to be interesting to see because you don’t have the OCC that’s got the same controls over strictly a bank market. Gregory: And the banks are not totally rational in working with the private equity funds. They might have a relationship with a private equity fund that could do 20 deals in a year, and they’re going to put extraordinary pressure on the bank to go outside of their comfort zone, and they’re very good at doing that. Cowen: There are a lot of new banks that have opened up, some of the smaller, regional ones, and they’re being very aggressive out the door and I will tell you there are deals getting done that we’ve been involved with that are getting done that would not have gotten done three or four years ago. Question: Recently, we all learned that Wendy’s sold Baja Fresh for a fraction of what the company bought it for just a few years ago. Is there a lesson there for large corporations that acquire entrepreneurial companies? Johnson: Absolutely. Part of the reason the General Electric model works is their stated objective with their (acquired) divisions is to be number one or number two in their space, and they make the (divisional) CEOs responsible for that business. The holding company is responsible for providing overhead, administrative services, auditing, to some degree legal and low cost financing, but the fact is that CEO makes or breaks that business on his or her own. That’s the right way to do it. Reinke: There’s too little due diligence going on in any acquisition. If you are going to stay with a company and want to match up with a company that’s going to be a good cultural fit you should do as much due diligence as you can about the culture of that company, about the goals of that company, the outlets that they have, to see if it is a good acquisition. It isn’t all about financing. A lot of clients can get a lot more money from one company but they’ll decide to go with another because the personality feels better. Question: If there is all this activity and frenzy and people are making deals that are not as thoughtful as they could be, does this mean we’re in for a number of business failures down the road? Reinke: I think the bigger issue will be not necessarily failures but deals that weren’t as successful as they could have been a lower value or not as much as they thought they would get (when they go back to market to sell). I see that as being more the case than complete business failures. Cowen: Some companies will be sold for a lot less than what they were bought for.
