How do M&A advisors create value?

How do M&A advisors create value?

18. Oct 2021 | Insights

When business owners decide it is time to sell their company, they have to answer the questions „Do I really need to hire an M&A advisors or does it make more sense to do it myself“? Although there are many benefits to hirings an advisor, some business owners still choose to bypass the intermediary, thinking the value is overstated. The point of this article is to discuss the overall value to a business owner of hiring someone to assist them in selling their company.

Do M&A advisors create value?

An independent study entitled „Does Hiring M&A Advisers Matter for Private Sellers?“ conducted by researchers from the University of Alabama examined the decision and the consequences of hiring sell-side M&A advisors. The study authors gathered and analyzed data from 3.8281 acquisitions of private firms and found out that 53% of private sellers do not use an M&A advisors. The results of the study definitely speak in favor of hiring an intermediary: sellers who retain an advisor receive an increased acquisition premium of 6 – 25% % more over a seller that attempts to sell the company on their own.

Going back to the initial question, it appears that M&A advisors create real value for a private seller. But how and where do they create value?

How do M&A advisors create value?

1. Expertise & Experience

When owners pursuing the sale of their business for the first time, a common challenge is that they do not know what they do not know. There are many steps in the process – from the business valuation to the preparation of the confidential business report (CBR) to the sourcing of buyers to negotiations and due diligence. An experienced M&A advisor has gone through those steps and processes over and over again and can therefore help owners to avoid common deal breakers, ask the right questions, ensuring a structured and well-planned process and finally execute a successful deal.

One very important document in the sales process of a business is the confidential business report (CBR). This document is shared with potential buyers and should educate the buyers about the company, excite them about the investment opportunity and move the transaction forward by providing buyers important information about the business. Professional advisors are experts on how to write the CBR and put the business for sale in a favorable light.

Another very crucial step in the sale of a business is an accurate valuation. Advisors provide the business valuation analysis which is needed by the seller to evaluate the reasonableness of a buyer´s potential offer. For instance, a seller may believe that the business is worth around €10 million, but based on an objective valuation, its M&A advisor may value it around €15 million, even before considering the value of synergies. Experienced advisors are specialists in the valuation of companies in accordance with international valuation methods which usually requires a lot of expertise and experience.

2. Bargaining Power

Private mid-market companies are less visible and receive less attention than publicly traded companies. This leads to fewer bids from investors. M&A advisors typically have the right business relationships, databases and the networks that they can utilize to identify financial and strategic buyers. A larger pool of potential buyers will result in a higher number of competing bids which creates a healthy competitive tension among buyers. Like supply and demand, a seller has more bargaining power when prospective buyers are competing with other bidders. An M&A advisor helps generating competition which will ultimately result in a higher acquisition premium for the business.

3. Credibility

A professional advisor also adds credibility to the sale of the business. Buyers know that the information provided to them are accurate, thorough and well-structured when an M&A advisor is involved. Professional investors often receive an enormous amount of investment opportunities, which they have to filter. Very often they will not even pursue an acquisition unless the business owner hires professional intermediaries. Professional buyers know from experience, that the whole sales process takes a significant amount of work and expertise. Dealing with M&A advisors gives them a strong feeling of confidence about the presented information, an efficient process of reviewing the opportunity and a higher chance of a successful closing.

4. Protection of the owners interest

Especially in the world of mid-market companies, the business is very often the „owners baby“. Selling can therefore be an emotional process. A professional advisor understands how to approach the business owners’ fears, answers questions and act as a middleman during negotiations with potential buyers. This is often crucial as direct negotiations between the parties can lead to a breakdown of the deal. Both sides will be under pressure at times and benefit from having a buffer that keeps the communication and the deal process on track. Experienced M&A advisors know how to handle investors during negotiations and know how to deal with tough and demanding buyers during due diligence.

Another important aspect is the protection of confidentiality. It is extremely difficult for a seller without a third-party advisor to go out to the entire market and keep their company sale confidential. M&A advisor know how to approach potential buyers without disclosing the identity of the seller. Every buyer should sign a non-disclosure agreement (NDA) before knowing anything about the company and its owner.

5. Reduction of workload

Most SMEs do not have a corporate development team. This means that those who are in charge of the sale of the company like the CEO, CFO or other executives, are also busy within their day jobs. However, the sale of a business requires an enormous amount of time and attention. If done without a third party advisor it would be inevitable that the responsible executives need to split their time between their daily tasks and the sales process. An M&A advisors can therefore augment a company’s internal resources.

Conclusion

The sale of the own company is likely to be the most important financial decision of a business owner. The primary reason sellers do not seek help from professional advisors is because of the perceived cost. However, when you look at the value provided by an M&A advisor during the sale process, that perception is proven inaccurate.

The study „Does Hiring M&A Advisers Matter for Private Sellers?“ provides empirical evidence that financial intermediaries improve M&A outcomes for private sellers, which are likely to lack deal-making experience and negotiating skills. Overall advisor-assisted private sellers receive an acquisition premium of 6–25% relative to their unassisted peers. Given the fact that mid-market advisors typically charge fees of 1-6% depending on the deal size, it is reasonable to conclude that experienced M&A advisors do add tangible value to a sales process.

Author:

Simon Fabsits, MSc

Dealbridge M&A Advisors Austria & Liechtenstein

Key Value Drivers of a DCF Analysis

Key Value Drivers of a DCF Analysis

20. Apr 2021 | Insights

Among many investment bankers, M&A consultants, university professors and other financial professionals, the Discounted Cash Flow analysis is considered as the gold standard of business valuation. A DCF analysis is a very flexible and accurate way to evaluate a project, division or entire companies.

Any DCF analysis, however, is only as accurate as the assumptions and forecasts it relies on. Errors in estimating key value drivers can lead to a very distorted picture of a company´s fair price. Depending on the determination of the key value drivers, the enterprise value for the same company can differ greatly. Therefore, every DCF analysis has to focus on a careful determination and justification of those important parameters. This article is intended to give an overview of the key value drivers and discuss their influence on the enterprise value.

Free Cashflow projections

Since the cashflows usually have the strongest influence on the enterprise value, the projection of the free cashflows is the decisive aspect of every DCF analysis. The development of the cashflows depend on various value drivers such as sales growth, profit margin, investments in fixed assets (CAPEX) and investments in working capital. These value drivers will be discussed below.

1. Sales

Logically, if all other value drivers remain the same, higher sales lead to higher cash flows and thus to a higher enterprise value. However, the assumption that other factors will remain unchanged with higher sales is unrealistic and untenable. For example, an increase in sales usually also entails additional investments in working capital. If the company encounters its production capacities at certain sales levels, investments in fixed assets must also be taken into account. The effects of the change in sales can therefore not always be clearly determined at first glance.

When planning sales, it is advisable to take into account the development of the entire economy, the industry and of course, the company´s position in the market. This results in a much more valid forecast of the turnover figures than a simple linear continuation of the turnover growth rates of the past.

2. Profit Margin

In contrast to an increase in turnover, a reduction in costs always has a value-increasing effect. If the company succeeds in reducing costs (ceteris paribus assumption), the EBIT margin and thus also the free cashflows and the enterprise value will increase.

3. Working Capital and CAPEX

Even if sales remain unchanged, there may be changes in working capital. Thus, for example the payment modalities of the customers or also the own payment modalities can change. Higher payment terms of the customers lead to an increase in trade receivables and thus to an increase

in the working capital requirements. The opposite effect is caused by greater utilization of the company’s own payment terms.

Investments in fixed assets (CAPEX) can largely be derived from the schedule of fixed assets. If replacement investments in fixed assets were not made in the past, they must be made sooner or later. In this case the future investments in fixed assets increase in comparison with those in the closer past, even if the conversion remains constant. A further reason for increased investments can be technical innovations of the own machinery. All these factors must be taken into account when forecasting capital expenditures.

Cost of Capital – Discount factor

The effect of the costs of capital on the enterprise value is immediately apparent. If the return requirements for debt and equity, and thus the discount factor increase, the cashflows will be discounted with a higher factor which results in a lower enterprise value. Mathematically, this relationship is clear because the present value of the cash flows is directly dependent on the level of the discount factor and thus on the cost of capital.

The discount factor is influenced by the following parameters (if WACC approach is used):

1. Cost of debt: The cost of debt is usually determined by the following three factors:

· The risk-free interest rate: If the risk-free interest rate rises, the cost of borrowing also rises.

· The default risk or risk premium: If the default risk of the company being valued increases, the cost of borrowing also increases.

· tax effect: as the cost of debt capital (interest payments) is tax deductible (tax shield), the cost of debt capital is reduced.

2. Cost of equity: If the return requirements of equity investors increase, the enterprise value decreases. In a DCF analysis, the cost of equity is usually calculated using the Capital Asset Pricing Model (CAPM). The amount of the cost of equity depends on the factors of the risk-free interest rate, the market risk premium and the beta factor.

3. The capital structure: The cost of capital of the company and also depends on the capital structure. As a rule, financing with equity capital is more expensive from the company’s point of view than with borrowed capital. Debt capital providers receive fixed payments that are independent of the profit generated. Equity investors, however, demand a risk premium due to the uncertainty of the payments to which they are entitled.

Growth rate of the Terminal Value

The growth rate of the cashflow in the Terminal Value reflects the growth of the cashflow at the end of the detailed forecasting period. This growth rate is intended to reflect corporate growth to infinity. It therefore makes sense to use a variable such as general economic growth as the growth rate for the company. In practice, growth rates between 0 and 3% are used, whereby 3% is the upper limit and is only used for companies in extremely dynamic industries. An increase in the growth rate from 1% to 3%, for example, results in an enormous increase in the Terminal Value and thus also in the enterprise value.

Length of the Forecast period

Contrary to the widespread opinion that the length of the detailed forecasting period does not affect the present value and thus the enterprise value, a change in the enterprise value can very well be observed when extending or shortening the detailed forecasting period in the DCF analysis. The direction and the extent of the change of the enterprise value depends on the individual case.

Usually, the growth rate applied in the years of the detailed forecasting period is significantly higher than the growth rate in the Terminal Value. Many companies are also planning a continuous increase of the EBIT margin during the planning horizon. If the forecast period is extended, the Terminal Value is calculated based on a higher cashflow (cashflow of the last detailed planning period). This results in a higher Terminal Value and thus also in a higher enterprise value.

Conclusion

The analysis of the value drivers not only serves to sensitize the user to the most important parameters of a DCF analysis but is also helpful in decision-making. Whether an acquisition or sale is the right decision depends on the price of the company. In the DCF analysis, however, this fair price is determined on the basis of forecasted figures that are subject to uncertainty. Therefore, when determining an enterprise value, different scenarios should always be considered that reflect this uncertainty. It is therefore advisable to analyze the enterprise value with multiple variants of the key value drivers. Three scenarios should be considered and analyzed: a base case, which represents the most probable development, a best case, which represents a very positive development, and a worst case, which represents a negative development. For each of the resulting scenarios, the company value is determined so that a value range is obtained.

 

Author:
Simon Fabsits, MSc
Dealbridge M&A Advisors Austria & Liechtenstein