Merisis Capital Advisors Pvt. Ltd. Mergers & Acquisitions I Syndication I Advisory

M&A – A Sellers Perspective

Sumir Verma

sumir@merisis.in

• M&A Trends

• Rationale for an M&A

• Typical Process

• Key Issues

Outline

• Earlier the confines of the larger companies and new age industries

• Increasingly family businesses have recognized M&A as a valid end to their tenure.

• India continues to attract FDI who recognize the pitfalls of a green field entry strategy –

– USD24.3 billion worth of inbound deals recorded during the year 2010

• India is increasingly acquisitive –

– 2010, most active year in terms of outbound investments for the country

– 95 transactions boosted outbound deal value to USD24.6 billion

• Does M&A make sense – Yes for both buyers and sellers

M&A - Trends

Rationale

Markets

Pro

du

cts

Exis

tin

g N

ew

New Existing

Consolidation Entry Strategy

Integration / Portfolio expansion

Diversification

•Expanding

Geographically

•Buying Growth

•Size

•Management Control

•Management Incentive

•Defending against

competition

•Tax Benefits

•Adding

Capabilities

•Leveraging

Consumer Base

•Innovation

•Economies of

Scale

•Efficiencies

•Higher

Distribution

•Cross selling

Financial Model with at least 6 mths. realistic forecasts Pitch done showing industry Attractiveness/ Co. attractiveness Recast past nos. if required Teaser

Pitch doc with details like synergies, positioning of the client Cost of targets

Decoding Strategy Negotiations Closure

Making a note of the M&A objective • Family succession • Consolidation • Poor financials • Good mkt. conditions • Good valuations Studying market segment •Educating Client • See commercials Inv. • Rivalry in the sector • Benchmarking • Market Comparisons Study financials • Recast as mgmt. financials • Create realistic projections

Valuation Structure • Criteria development • Target Identification •Initial short listing • Selection of process (Bid out or one on one) • Valuation exercise • Internal v/s . External Touching base with prospects • Talking to prospective parties •Taking a sense of the interest levels • Further information sharing • Gauging expected pricing Final Short listing

Detailed due diligence • Commercial due diligence • Legal & regulatory due diligence • Financial due diligence • Technical due diligence Developing negotiation strategy • Analyzing deal terms • Analyzing feedback • Freezing on timelines Documentation •Develop & finalize the term sheet Structuring the transaction • All cash/Equity deal •Considering the tax implications on both sides

Resolving Causal linkages • Setting up escrow accounts • Third party guarantees • Sorting Reps & warranties Setting up agreements • Share purchase agreement • share subscription agreement • employment agreement • supplier agreement • trademark agreement • Escrow agreement • Business plan Closure •Signing • Transfer of funds/ shares

Term Sheet Commercials

6 weeks 8-12 weeks 8 weeks

The Process

Deal Done….I am off for a holiday!!!

60% of the deal value to be recovered over the next 2-3 years

Key Issue 1: Understanding how deals are structured

Consider such structured deals a given in most cases

Payment Linked To Projected EBIDTA

Company Revenue 40 Cr

Expected Valuation 60 Cr

Actual value offered by acquirer 80 Cr

Year 0 Year 1 Year 2 Year 3

Structure of payment 30 Cr

(Upfront) 10 20 20

Projected Sales 70 100 120

Projected EBIDTA 10.5 16 20.4

Its all about the money honey!!

Focus on the fine print

Key Issue 2 : Excessive focus on figurehead price tag

• Key points

– Focus should be on considering different scenarios and testing where risks lie

– For example

• Sales linkage or Ebitda or a mixed formula

• Aggressive ness of the projections

• Sliding scale for payout or a step process

• Level of Floor for Variable

• Carry forward of underachievement

Payment Linked To Projected EBIDTA

Company Revenue 40 Cr

Expected Valuation 60 Cr

Actual value offered by acquirer 80 Cr

Year 0 Year 1 Year 2 Year 3

Structure of payment 30 Cr (Upfront) 10 20 20

Projected Sales 70 100 120

Projected EBIDTA 10.5 16 20.4

The handshake is done - price is figured out.. The deal’s done

Due diligence can kill the deal

Key Issue 3 : Poor Book keeping

• Understanding what a banker will do – Creating the business model

– Valuation

– Identify the prospective buyers and connect

– Negotiations

– Drive the transaction

– Involve lawyers, tax consultants, company secretary etc.

• Complex activity

– Specific knowledge of corporate finance, tax, accounting, legal regulations

– Experience of negotiating and creating demand

• Needs time and focus

– Typically owners underestimate the time that M&As take – could stretch beyond a year

– Need an external body that prevents the owner from defocusing on business

–

1. Getting Ready – Hire a banker !

Don’t be pennywise and pound foolish

Core Value

• Discounted cash flows

• Listed company benchmarks

• Multiples of Ebitda / Sales/ PAT

• Price to Book Value

• Comparable Transactions

2. Understanding Intrinsic Price – Quantitative methodology

Price

Synergy sharing

• Cost Rationalization

• Cross Sell

• Enhanced Revenues

• Is shared with the acquirer

Control Premium

Typically 15%-30% of Core Valuation

An example of the Synergy valuation

• It is a myth that since valuation models are quantitative, valuation is objective

• It is a matter of the buyer’s perception – reflection of his view of the industry

– Reflection of his view on what will be the growth trajectory of the company

• Importantly is a function of demand and supply

• Finally it is about timing too – Sell high i.e. when it is doing well

Understanding Valuation - Qualitative aspect

…Be realistic about pricing

1. Create a realistic bottom up financial projection for the next 6 months and next 2.5 years

1. 2 years - this is what the payout will get linked to

2. 6 months - these are the figures the potential buyers also evaluate and build comfort

2. Realistic assumptions take into account

1. Business cycles

2. Capital expenditure requirements

3. Working capital demands etc.

4. Semi variable nature of overheads

3. Normalising accounts

1. Correct accounting practices

2. Correct anamolies in current financials in the projections

3. Management accounts which give a truer statement of the financials

4. Protecting the price

An example of how you can go wrong

Payment Linked To Projected EBIDTA

Company Revenue 40 Cr

Expected Valuation 60 Cr Actual value offered by acquirer 80 Cr

Year 0 Year 1 Year 2 Year 3

Structure of payment 30 Cr

(Upfront) 10 20 20

Projected Sales 70 100 120

Projected EBIDTA 10.5 16 20.4

Actual EBIDTA Achieved 7 9 12

Minimum EBIDTA required to be earned- 75% of Projected 7.875 12 15.3

Part Payment Actually Received 0 0 0

•Valuation Offered – 2x Revenue •Payment of future installments is subject to the company achieving at least 75% of projected EBIDTA •But the actual EBIDTA achieved is less than the minimum requirement. •The company does not receive the remaining three installments.

•It only gets 30 Cr from the entire deal

•Actual Valuation – 0.75x Revenue

• Deals break at due diligence stage – high percentage

• Too many small issues – lower confidence

– Either lower valuation or

– Break the deal

• Advisable to do a pre due diligence exercise by hiring a professional who does a legal and financial due diligence

• Examples of issues that have come up which have delayed deals

– Land / Building documentation

– Non adherence to standard company secretarial practices

– Non payment of statutory dues

– Inter se promoter shareholding issues

• Also understand

– The mode of sale – shares, slump sale, merger and impact

– On the tax issues – stamp duty, VAT, Capital gains etc.

• Some of these issues have delayed deals by over 3 months, which is risky

5. Focus on the nitty gritty

• If it is straight sale, this is not an issue

• However if it is a joint venture or a structured deal, comfort with the buyer is crucial

• Specially for entrepreneurs who have never worked for /with others !

• More important than wringing the last cent out..

Qualitative aspects

• Merisis Capital Advisors is a leading independent investment banking advisory firm serving the middle market companies and their owners

• Founded by three investment professionals each with 15 years of corporate finance experience with complementary skills and domain knowledge

• Ability to cater to a wide range of domains, client requirements and customer segments

– Services : Capital Raising & M&A – Domestic & Cross-border

– Capital raise ticket size : Venture Capital funding ($2-5 million) to PE Funding($5-$25 million)

– Experience set :

• Ability to deal with early stage entrepreneurs as well as CXOs of large corporations

• Be an advisor to our clients in matters of corporate strategy and institution building

• Ability to evolve Structured financing

• Differentiators

– Significant connects across the investment ecosystem – Funds and Intermediaries

– Strong Execution and Closure capabilities

– Performance culture fostering meritocracy across the company

• For more information on Team, Deals and Sector coverage, please visit us at www.merisis.in

About Merisis Capital Advisors

Thank You sumir@merisis.in