The M&A Process for Startups and Growth Companies
Mergers and acquisitions aren’t exactly an everyday process for most startups. They only come around occasionally, and are typically full of complex issues many business leaders have never encountered before.
And that includes finance experts. Many seasoned CFOs have never had to deal with a serious M&A. It can be confusing and nerve-wracking, and can take the enjoyment out of what should be a very exciting time for your business.
So I’m here to shed some light on the M&A process. Despite being complex, mergers and acquisitions tend to follow a familiar pattern, with key checkpoints along the way. We’ll examine these in this article, and I’ll add some helpful advice as we go.
In particular, we’re looking at the process from the seller’s point of view. As a startup CEO or CFO, what do you need to know when you’re thinking about selling the business or finding new financing through M&A?
But first, a quick introduction.
About me and Startupfinanzen.de
As a founding partner at Startupfinanzen.de, I advise growth-oriented companies on national M&A transactions, growth financing, and complex corporate restructurings. In particular, my work focuses on the retail, technology, art & culture, and media & entertainment sectors. I’ve also completed significant transactions in the healthcare sector and have a strong personal interest in the fashion & luxury sector.
At Startupfinanzen.de, we help startups and growing companies with financial planning, growth financing, the sale of startups (the “exit”), and corporate restructuring / recapitalization.
I’ve spent my career as a business economist with a specialization in M&A. This includes time as Head of Finance & Controlling at a 50-employee startup in Cologne. Prior to this, I worked in investment banking with a focus on M&A, corporate finance and ECM in an M&A boutique.
But enough about me. Let’s get to the important stuff.
What are mergers and acquisitions (M&A)?
M&A is shorthand for mergers and acquisitions, and a collective term for company transactions. In essence, it entails one company combining with another, either by acquiring it (or part of it), or by being acquired (in whole or in part).
There are countless instances of famous M&As, but recent examples include Disney acquiring Pixar, Disney acquiring Star Wars (Lucasfilm), and Disney acquiring Marvel. And now all of this content is on Disney+.
Broadly speaking, M&A is a part of corporate finance and investment banking.
Key professionals involved in M&As
An M&A won’t just complete itself. The typical transaction requires a range of skilled and experienced professionals, including:
Lawyers: Attorneys take care of the company purchase agreements and prepare the appendices, among other things. These are of particular importance.
Tax consultants: Tax consultants take over the tax structuring of the company transaction and optimize it accordingly. Because as with any purchase in life, there are taxes to pay.
M&A advisor: Most companies will want specialist advice. The M&A advisors manage and organize the M&A process from the identification of potential investors, to the preparation of relevant documents, to the negotiation of the purchase price.
Auditors: Auditors come along to take care of the due diligence, and make sure that both businesses are accurately represented.
If you’re embarking on a merger or acquisition, you’ll likely need input and assistance from all of the above. And obviously you then have CEOs, finance teams, investors, and other key stakeholders involved along the way.
The two main types of M&As
Our next key topic is to look at the most important types of M&As. And while of course every transaction will have its own quirks, they generally fall into two categories.
As the name suggests, an exclusive procedure involves only one investor or consortium of investors in the context of the company transaction. This is in contrast with the more open auction format, which we’ll look at next.
The advantages of an exclusive M&A are as follows:
- Chance of a quicker resolution. When you’re only dealing with a limited number of parties, the process moves much faster.
- Low spread of confidential information. You can be more confident that company data and secrets will remain safe, and that NDAs will be respected.
The disadvantages on the other hand are as follows:
- Very little room for negotiation. There’s little incentive for either party to give up much in negotiations, since they’re not competing with anyone else.
- No unexpected purchase price increases. With multiple potential buyers, auctions always have the potential to increase the purchase price.
Auctions are the more common M&A procedure. In an auction, negotiations are conducted with several investors at the same time.
This has the following advantages in particular:
- Possibility of purchase price increases. As mentioned above, auctions can cause prices to raise as buyers outbid each other.
- Large scope for negotiation. Sellers will be willing to make concessions to keep the purchase price increasing.
The disadvantages of this method are the following:
- Tedious process. It’s almost always slower than direct, exclusive negotiations.
- Highly distributed confidential information. You’ll have multiple parties needing access to potentially sensitive information.
How to identify investors and buyers
Choosing the right purchaser isn’t simply a matter of finding the investor who’ll pay the most.
When you found a company, finding the right co-founders is a vital step. You need people who complement each other through their respective strengths. And you should bring the same approach to finding investors: look at the strengths, know-how, and expertise they can bring to the company.
As we’ll see, there are two key kinds of investors to consider. But first, here are a few principles to consider when looking for buyers:
- Their particular expertise and know-how
- Their soft skills and public perception
As we said above, this is about more than simply finding the deepest pockets. We summed this up in a recent LinkedIn post.
The strategic investor is extremely important, or rather necessary, especially in the early phase of financing (Seed & Early Stage), since the startup typically needs know-how, network, etc. in addition to money (Smart Money). Only in this way can the startup build up sustainable growth and grow organically alongside the external financing of the strategic investors.
First, geography is important for logistical and cultural reasons. A young startup in Paris will naturally have difficulties with an investor in China or Africa, simply due to the distance. You need input and help, and physically distant buyers won’t be as helpful.
In the later stages it becomes more normal to have larger distances. The level of input here is usually far less.
Soft skills are often more important for younger companies. For example, it can be useful for a start-up in the field of sustainable clothing if the potential investor has a role in similarly positioned businesses - like an association for sustainability and environmental management. You need their specific know-how, and you benefit enormously from their visibility in a given industry.
Two kinds of potential investors
As we’ll see, early on in the process, you’ll create a long list of investors to consider. These should be broken into two broad categories:
A financial investor or private equity (PE) investor has an industry focus and is profit-oriented. Some PEs bring possible synergy potential due to other companies in their portfolio. Venture capitalists (VCs) fall into this category.
- More experienced in corporate transactions
- Rational decision makers
- Potential synergies to exploit
- Can potentially fragment the company
- Less concerned with losses
Strategic investors are usually competitors or other market participants. The strategic investor offers a greater market share, better positioning, specific industry know-how, or opens up whole new markets. And there are also many other possible synergies.
- Good know-how and strong network
- Great potential synergies to explore between existing products
- Often ample existing resources
- May interfere with the business operations
- Not always a clear investment strategy
- May take actions based on emotion
Your chosen investor ultimately needs to reflect the business needs at that given moment. Who is going to have the best interests of the company at heart, and who can propel it forward?
Crucial documents in the M&A process
This is a corporate transaction. So naturally, there will be paperwork. Here are some of the crucial elements which can almost never be excluded.
Non-disclosure agreement (NDA)
An agreement between the parties to a merger or acquisition. Provides protection against the misuse of data.
An NDA is typically used at the beginning of the M&A process. The NDA will be sent to potential investors including the short profile (which we will discuss later). The reason for this is that, once signed, you have a first expression of interest from the potential investor.
Once signed, the parties are obliged to keep confidential information hidden from uninterested investors or other parties.
Letter of intent (LOI)
A formal record of the negotiations. Shows the serious intent of both parties to enter into this corporate transaction.
The LOI typically comes into existence after the NDA is signed by the potential investor. The potential investor will receive further information after the NDA has been signed (including the Information Memorandum - this document will be discussed later).
The LOI formally expresses the parties’ intent to enter into this M&A transaction.
The long list (of investors)
This document is very important to the seller (you), but doesn’t pass to the buyer. First, the M&A advisor prepares a so-called “long list” of potential investors. You work with them to narrow it down and evaluate potential suitors.
Typically, this shortlist is then used as a working document, and forms a status report. The status report is especially important to reflect the current state of the M&A process.
Documents for due diligence
Since every company transaction is a unique transaction, the requirements regarding the necessary documents are constantly changing. For this reason, the M&A advisor typically works with the start-up to develop a data requirements list for the relevant documents. These include commercial numbers, tax, legal and financial facts, marketing documents, as well as sustainability, IT licenses and patents. The data requirement list and the specifics of each individual transaction then become very clear during due diligence.
Speaking of which, here’s a list of the kinds of documents you should expect to have to produce:
- Profit and loss statement
- Balance sheet
- Cash flow statement
- Annual financial report
- Financial planning (up to 3 years)
- Keeping an eye on cash flows
- Plan and actual comparison (optimization potential)
- Corporate planning (continuous improvement)
- Overview of the company's capital structure (who holds how many shares, and what is their value?)
- Consideration of the pre- & post-money valuation
- Financing rounds with the amount of injected capital
And there are two more highly important documents: the short profile and the information memorandum.
The short profile
The short profile, prepared in cooperation with the M&A advisor, reflects the investment highlights of the company in a compact summary. Typically, this will be between 5 and 10 pages long.
For companies which are already in a larger phase of their development, it may make sense to send a blacked-out version of the short profile to potential investors. This way you ensure that investors can’t draw any direct conclusions about the company. You don’t want to give too much away.
The information memorandum
The information memorandum is usually the first buyer-side due diligence document, and is very comprehensive. In practice, this document can also be a modified business plan for the transaction.
If the potential investor is still interested (they’ve signed the LOI), the due diligence is therefore pending. Depending on the phase of the company, the due diligence can be of different sizes. For larger company phases, data rooms are used; for smaller phases, an evaluation of the information already sent and various management meetings are often sufficient.
Finally, both parties are in final negotiations on the respective conditions. Once these have been clarified, the signing and subsequent closing can take place.
The M&A process is always complex
Over the past 2,000 words, we’ve barely scratched the surface of what you can learn and expect from mergers and acquisitions. You now know who’s going to be involved, and what you need to produce.
But until you’ve been through the process a handful of times, you’re never really sure what’s to come.
If I could leave you with three key takeaways, they’re these:
- Be prepared. Do your homework, talk to peers, and make sure you have the data you’ll need.
- Ask for help. I can’t stress enough how valuable experienced M&A advisors are during this adventure.
- Take your time. With any exciting business venture, you simply want it to happen to enjoy the rewards. But comparing offers, doing careful negotiations, and “sleeping on it” are all part of the process.
Being a startup executive is all about making informed, calculated decisions. The next big M&A could be your company’s big break, so it pays to get it right.
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