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Middle Market M & A: Handbook for Investment Banking and Business Consulting


Praise for Middle Market M&A

"Of all the situations we address in investment banking, M&A is the most complex. Valuation, tax, regulatory, and differing structures are but a few of the issues that require extra thought and diligence. Middle Market M&A is the best reference that one can use for both background as well as a practical execution guide. It outlines the same tools we use on a daily basis."
Christopher W. Gaertner, Managing Director and Co-Head, Technology Investment Banking, Bank of America Merrill Lynch

"Middle Market M&A is a must-read for business development professionals serving the middle-market M&A sector. This is a comprehensive resource that provides valuable insights that are certain to increase your deal-making success."
Patti Gillenwater, CEO, Elinvar, and Board Member, ACG Global

"A labor of love—I will be dipping into this book for years to come. It has a strong grasp of both passing trends and lasting principles. It is good on the technical side, without sacrificing the bigger picture and the better deal."
Mike Sweeting, Head of Partnering, BCMS Corporate

"A superb treatise for honing your M&A skill set. It provides tremendous insight for executives and professionals engaging in middle market M&A transactions."
Robert Loewer, JD, MBA, MSA, General Counsel and Director of Finance, National Railway Equipment Co.

"Here in one volume, the authors provide timely, relevant insights and time-tested techniques for successfully engaging in middle market M&A. For those who are considering an M&A transaction—whether as a buyer, a seller, an advisor, or a provider of financing—the advice contained in these pages should be required reading."
Cal Hackeman, National Managing Partner, Technology Industry, Grant Thornton LLP

KENNETH H. MARKS, CM&AA, is founder and a Managing Partner of High Rock Partners, Inc. He is the lead author of The Handbook of Financing Growth: Strategies, Capital Structure, and M&A Transactions (Wiley). He has been involved as management, advisor, and board member with many emerging growth and middle market businesses.

ROBERT T. SLEE, CM&AA, is Managing Director of Robertson & Foley, a middle market investment-banking firm. He has published over 100 articles on private finance topics in a variety of legal and business journals. He is the author of Private Capital Markets (Wiley).

CHRISTIAN W. BLEES, CPA, CM&AA, is President and CEO of BiggsKofford PC, directing several sectors of the business including the firm's merger, acquisition, and sales practice. He has been involved in over 200 middle market M&A sales transactions.

MICHAEL R. NALL, CPA, CM&AA, is founder and CEO of the Alliance of Merger & Acquisition Advisors, a Chicago-based professional trade association featuring a resource and development center serving more than 600 independent accountants, attorneys, and business advisors. He is an author and recognized speaker on valuation, growth, and sales of middle market companies.

Preface xv

Acknowledgments xix

PART ONE The Middle Market 1

CHAPTER 1 Private Capital Markets 1

Segmented Markets 4

Why Are Markets Segmented? 7

Capital Providers 9

Owners' and Managers' Views of Risk/Return 10

Buyers 11

Market Activity 14

CHAPTER 2 Valuation Perspectives for the Private Markets 17

Private Business Valuation Can Be Viewed through Different Standards of Value 18

Market Value 21

Fair Market Value 22

Fair Value 22

Incremental Business Value 23

Investment Value 23

Owner Value 23

Collateral Value 23

Book Value 24

Why the Different Versions of Value? 24

Valuation as a Range Concept 25

Value Worlds and Deals 26

An Alternative Valuation Approach 26

CHAPTER 3 Corporate Development 27

Why Acquire? 28

The Dismal Ds 29

Alternatives 30

The Acquisition Process 31

The Pipeline and Filter 32

Approaching the Target 33

The Balance between a Deep Dive and Locking In the Deal 34

Lower-Middle Market versus Middle Market Deals 34

Valuation from a Strategic’s Perspective 35

Structuring the Transaction 37

The Bid 38

Due Diligence 38

Integration 41

Case Study #1 42

Strategic Rationale 42

Challenges 43

Transaction 44

Lessons Learned 44

Case Study #2 44

Practical Tips and What Causes Deals to Fail 47

What Should We Acquire? 47

Why Are We Doing This? 48

Alignment of Interests 48

Allocate Enough Resources 49

If It Can Go Wrong, It Will Go Wrong 49

CHAPTER 4 A Global Perspective 51

Advantages of Global M&A 52

Challenges to Global M&A 52

Negotiations and the Importance of Cultural Tune-In 55

Strategic Due Diligence 56

Postmerger Integration: Are the Odds in Your Favor? 59

From the Start: Think Integration 61

Acquisitions that Build Value 62

1. Set Clear Expectations and Invest in High-Quality, Two-Way Communication 63

2. Acknowledge Cultural Differences but Simultaneously Create a Common Corporate Culture with a Single Goal: Achieving High Performance 64

3. Move to a Cross-Border Operating Model 65

The Legal Environment and the Acquisition Process 66

The Legal Environment and the Conduct of Business 67

Taxation 68

Labor 68

Foreign Corrupt Practices Act (FCPA) 69

Success Factors 70

PART TWO The M&A Practice and Processes 71

CHAPTER 5 Practice Management 73

Primary M&A Advisors 74

Marketing the M&A Practice 76

Networking 76

Marketing and Advertising 77

Pretransaction Consulting 77

Valuation Services 77

Other Consulting Services 78

Becoming an Expert 78

Understanding the Private Business Owner 78

Client Acceptance 79

Initial Financial Analysis 82

Value Discussions 82

Process Discussions 82

Confidentiality 83

Client Engagement 84

Identification of the Parties 85

Scope of Service 85

Limitations and Disclosures 86

Fees 86

Double Lehman Formula 87

Termination and Tail 88

Licensure Issues in the M&A Business 88

CHAPTER 6 Sell-Side Representation and Process 91

Selling Process Overview 91

Step 1: Data Collection 92

Step 2: Industry Research and Identifying Buyer Types 94

Step 3: The Marketing Book 95

Step 4: Marketing Process 99

Step 5: Negotiating Price and Terms 102

Step 6: Structuring the Transaction 106

Step 7: Receiving Letters of Intent or Term Sheets 109

Step 8: Due Diligence 111

Step 9: Definitive Agreements 112

Step 10: Closing Process 114

CHAPTER 7 Buy-Side Representation and Process 117

Strategy 117

Engagement and Fees 119

The Filter 119

Financing 120

Quality of Earnings 120

Coordination 122

Integration 122

CHAPTER 8 Mergers 123

Initial Analysis of Both Entities 123

Strategic Rationale 124

Valuation Modeling 125

Understand Cost, Operational, and Cultural Differences 125

Develop the Integration Plan 127

Deal Structure and Negotiations 127

Due Diligence 128

Legal Process and Closing 129

Postclosing Integration 130

CHAPTER 9 Professional Standards and Ethics 131

Role of the M&A Advisor in the Economy 132

A Whole New Way 133

The Middle Market Standard 134

Ethical and Professional Standards 134

Competence and Professionalism (Reputation) 134

Best Practices (Activities) 135

Ethics (Behavioral Boundaries) 135

Country Specific (Customs) 136

PART THREE M&A Technical Discussions 137

CHAPTER 10 Financial Analysis 139

Financial Reporting Motivation 139


Balance Sheet Analysis 142

Working Capital 142

Normalization 148

CHAPTER 11 Deal Structure and Legal Documentation 151

Attorney's Role 151

Preliminary Legal Documents 153

Confidentiality Agreement 153

Letter of Intent 154

Structure of the Deal 155

Stock Sale/Merger 155

Asset Purchase 157

Section 338(h)(10) Election in a Stock Sale 160

Purchase Price 160

Consulting and Employment Agreements 161

Due Diligence 161

Acquisition Agreements 161

Representations and Warranties 162

Qualifications to Representations and Warranties 163

Indemnification 163

Earnouts 164

Parameters 165

Benefits of Earnouts 165

Shortcomings of Earnouts 165

Regulatory Compliance 166

CHAPTER 12 Tax Structure and Strategy 168

Tax Fundamentals 168

Transaction Tax Basics 172

Asset Transactions 172

Stock Transactions 174

Stock versus Asset Sale Example 175

Negotiations Based on Structure 177

Asset Transaction Details 179

Buyer Tax Issues 185

Tax Glossary and Reference 188

CHAPTER 13 Tax Provisions Used in M&A 193

Installment Sales 193

Risk of Forfeiture 194

Assets that Qualify for Installment Treatment 194

Installment Planning Opportunity 195

Section 1031 (Like-Kind) Exchanges 196

Third-Party Exchanges 196

Partnership M&A 196

General Partnership Doctrine 197

Partnership versus S Corporation 197

Partnership Gain Tracking Rules 200

Purchase Price Allocation for Partnership Buyers 200

Corporate M&A Issues 201

Contributions to Corporations 201

Mergers and Reorganizations 202

Net Operating Loss Limitations 206

Stock/Asset Sale Election: Section 338 206

S Corporation Issues 208

Tax Glossary and Reference 210

CHAPTER 14 Regulation and Compliance 215

Protecting Investors: Securities Act of 1933 215

Exemptions under the 33 Act 216

Commonly Used Private Placement Exemptions 217

Keeping the Markets Honest: Securities Exchange Act of 1934 219

Requirements and Rules 219

Williams Act 220

Antitrust Issues and Laws You May Encounter in the Deal 221

Hart-Scott-Rodino Act 221

Specific Industries 222

Exon-Florio 223

Other Regulatory Issues and Laws You May Encounter in the Deal 223

Bulk Sales Laws 223

The WARN Act 224

The Investment Banker's Perspective 224

SEC Provisions for Broker-Dealers 225

Investment Advisers Act and Investment Company Act of 1940 226

FINRA Provisions for Broker-Dealers 227

The Company’s Perspective 227

Process of Issuing and Selling Securities in the Deal 227

State Blue-Sky Laws 228

Considerations for Public Companies 229

CHAPTER 15 Financing Sources and Structures 231

Perspective 231

Buyouts 232

Buyout Deal Structure 234

Bridging the Valuation Gap 237

Recapitalization 237

Acquisitions 237

Financing Primer 239

Capital Structure 239

Factors Shaping the Capital Structure 243

Sources and Types of Funding 246

Debt 247

Private Equity 249

Personal Guarantees 251

CHAPTER 16 Due Diligence 255

Traditional Due Diligence 255

Financial Matters 257

GAAP Compliance 259

Tax Impact and Compliance 260

Compensation and Benefits 262

Legal 263

Information Technology 264

The Diligence Team 265

Due Diligence Process 266

Public versus Private 266

Impact of Globalization 267

Who Relies on Due Diligence? 267

Quality of Earnings 268

Financial Statement Audits 268

CHAPTER 17 Market Valuation 271

Reasons for Appraisal 272

Determine the Value Subworld 272

Calculate the Benefit Stream 273

Synergies 279

Determine Private Return Expectation 281

Specific Investor Return 282

Industry-Specific Return 284

General Investor Returns 284

General Acquisition Selling Multiples 284

Derive Value 285

Global Perspective 289

Epilogue for Business Owners 291

Appendix 297

Transaction Examples 297

Transaction Valuation 298

Tools, Models, Resources, and Templates 299

Glossary 301

Notes 337

About the Authors 343

About the Contributors and Reviewers 347

Index 361