xi

Table of Contents

Preface iii

Acknowledgements v

Dedication vii

About the Author ix

Introduction 1

Organization of the Book 2

SECTION IShareholder Value and Corporate Strategy 5

Introduction 5

Shareholder Value Measurement and Creation 6Measuring Shareholder Value 6Creating Shareholder Value 9

Foundations of Corporate Strategy Development 1 3Components of a Business Assessment 1 4Environmental Factors 1 4Industry Factors 1 6Internal Factors 1 8

xii Strategic Acquisitions

Stages of the Corporate Acquisition Process 1 9Corporate Strategy Development 20Searching for Target Companies 21Target Company Analysis 21Valuation and Pricing 23

Deal Structuring and Financing 24Negotiations 25Due Diligence 26Closing 26Integration 26Overlapping Stages 27

Timeline of the Acquisition Process 29

Conclusions 30

SECTION IISearching for Target Companies 33

Introduction 33

Acquisitions and Corporate Strategy 34Build vs. Buy 34Large vs. Small 36Public vs. Privately Held Companies 37Focus vs. Diversifi cation 39Domestic vs. Foreign Target Companies 42Defensive vs. Off ensive 43

Parameters of a Corporate Acquisition Program 44Acquisition Criteria 44Financial and Personnel Resources 45Using External Advisors 46Active vs. Passive Search for Target Companies 48

Active Search 48Passive Search 50

Confi dentiality Agreements 51

xiiiTable of Contents

Types of Seller 52Corporate Sellers 52

Public Companies 53Corporate Carve-Outs 53

Individuals 54Retirement 55Change in Lifestyle 55Compelled 56Financial Distress 56Opportunity 57Resource Scarcity 58Summary — Types of Individual Seller 58

Private Equity Firms 60Not-for-Profi t Entities 60

Acquisition Scenarios 61Single-Buyer Scenario 62

Buyer-Initiated Scenarios — Privately Held Companies 62Buyer-Initiated Scenarios — Public Companies 63Seller-Initiated Scenarios 64

Controlled Auction 64Eff ective Auction 65Conclusions 66

SECTION IIITarget Company AnalysisPART 1 — Analyzing the Strategic Fit and Value Drivers 69

Introduction 69

Target Company Analysis 70Primary Objectives of Target Company Analysis 71Approach to Target Company Analysis 72

Sources of Information 74Public Information 74Confi dential Information Memorandum 75Data Room 76Management Presentations 77

xiv Strategic Acquisitions

Reciprocal Information Disclosure 78

Strategic Fit Assessment 79

Revenue Base and Growth Prospects 82

Management and Employees 86

Sales and Marketing 90

Operations 93

Conclusions 96

SECTION IIITarget Company AnalysisPART 2 — Financial Analysis 99

Introduction 99

Sources of Information 1 00

Historical Financial Results 1 04Historical Income Statements 1 05Historical Balance Sheets 1 06

Net Operating Assets 1 08Interest-Bearing Debt and Equivalents 1 1 1Redundant Assets 1 1 2Cash on Hand 1 1 4Balance Sheet Segregation Example 1 1 5

Historical Cash Flow Statements 1 1 8

Financial Projections 1 1 9Projected Balance Sheets 1 22Cash Flow Projections 1 23

Ratio Analysis 1 25Liquidity Ratios 1 28

Current Ratio 1 28

xvTable of Contents

Quick Ratio 1 29Cash Cycle 1 29

Effi ciency Ratios 1 29Accounts Receivable Collection Period 1 30Inventory Turnover Ratio 1 30Non-Cash Working Capital Ratio 1 31Total Asset Turnover Ratio and Fixed Asset Turnover Ratio 1 31Capacity Utilization 1 32Sales per Employee 1 32

Profi tability Ratios 1 32Gross Profi t Margin 1 33Contribution Margin 1 33EBITDA and EBIT Margin 1 34Net Profi t Margin 1 34Degree of Operating Leverage 1 35Price per Unit and Gross Profi t per Unit 1 35

Financial Leverage Ratios 1 36Total Assets to Net Worth Ratio 1 36Debt to Total Capital 1 37Interest Coverage Ratio 1 37Debt Serviceability Ratio 1 37Debt to EBITDA Ratio 1 38Degree of Financial Leverage 1 38

Return on Investment 1 39Return on Net Assets 1 39Return on Equity Ratio 1 39

Conclusions 1 40

SECTION IVValuation and PricingPART 1 — Establishing Intrinsic Value 1 41

Introduction 1 41

Principles of Business Valuation and Pricing 1 43Components of Intrinsic Value 1 43

xvi Strategic Acquisitions

Intrinsic Value vs. Strategic Value and Pricing 1 47Public Equity Market Valuations vs. Corporate Acquisitions 1 49

Multiple of EBITDA Methodology 1 51Normalized EBITDA 1 51EBITDA Multiple 1 54

Target-Company-Specifi c Factors 1 54Market Dynamics 1 57Transaction-Specifi c Considerations 1 59General Ranges for EBITDA Valuation Multiples 1 62

Interest-Bearing Debt and Equivalents 1 62One-Time Income or Expense 1 64Net Operating Asset Adjustments 16 4Redundant Assets 16 6Real Estate Assets 1 68Issues with the Multiple of EBITDA Methodology 1 70

Multiple of EBITDA Less Capex Methodology 1 72Example of the Multiple of EBITDA Less Capex Methodology 1 73

Capitalized Cash Flow Methodology 1 74

Discounted Cash Flow Methodology 1 78Unlevered Discretionary Cash Flow 1 80

Forecast EBITDA 1 81Capital Expenditures 1 82Cash Income Taxes 1 83Net Trade Working Capital 1 83

Discount Rate 1 84Terminal Value 1 85Determination of Equity Value 1 86Summary of Valuation Conclusions 1 92

Other Valuation Tests 1 93

Conclusions 1 94

xviiTable of Contents

SECTION IVValuation and PricingPART 2 — Pricing and Deal Structure 1 97

Introduction 1 97

Synergies and Strategic Advantage 1 99Sources of Synergies and Strategic Advantage 200

Revenue Base and Growth Opportunities 200Management and Employees 201Sales and Marketing 201Operations 202Financial 203

Quantifying Synergies and Strategic Advantage 203Tangible Operating Synergies 204Intangible Operating Synergies 205Financial Synergies 205Costs of Realizing Synergies 206

Deal Structuring 207Assets vs. Shares 207Forms and Terms of Payment 209

Holdbacks 209Promissory Notes 21 0Share Exchanges 21 1Earn-Outs 212Majority Ownership Positions 21 4Value-Based Pricing Strategy 21 5

Management Contracts 21 7

Financing the Transaction 21 8Debt Financing 220Equity Financing 223Transaction and Integration Costs 224

Pricing the Target Company 225Pricing Model 225

Example of Pricing 229

xviii Strategic Acquisitions

Industry Transactions 236

Public Equity Market Multiples 238

Impact on Pro-Forma Consolidated Financial Results 241

Conclusions 247

SECTION IVValuation and PricingPART 3 — Establishing Rates of Return 249

Introduction 249

Defi ning Rates of Return 251Discount Rates, Capitalization Rates and Valuation Multiples 251Weighted Average Cost of Capital vs. the Buyer’s Target Return on Equity 255

Principles of Discount Rate Determination 257

Weighted Average Cost of Capital 259Unlevered Return on Equity 260

Risk-Free Rate of Return 260Public Equity Market Risk Premium 261Industry-Specifi c Risk Factors 262Target-Company-Specifi c Risks 264Other Adjustments 265SellerCo Example — Unlevered Return on Equity 266Empirical Evidence 266

Capital Structure Determination 267Capital Structure Example 271

Calculating WACC 273SellerCo Example — WACC Calculation 274Simplifi ed WACC Formula 274

WACC Capitalization Rates 276Terminal Value Risk Adjustment 278

xixTable of Contents

Buyer’s Target Return on Equity 278Corporate Hurdle Rates 279

Modifi ed Capital Asset Pricing Model 280Target-Company-Specifi c Risk Factors 282Strategic Advantage 283Transition and Integration Risks 284Contingency Payments 284Financial Risk Premium 285Buyer’s Target Return on Equity Example 287

Conclusions 289

SECTION VNegotiations 291

Introduction 291

Principles of Negotiation 293Information 293Alternatives 294Flexibility 294Credibility 295

Buyer’s Negotiating Team 296Internal Members of the Buyer’s Negotiating Team 297External Members of the Buyer’s Negotiating Team 298

Preparation and Research 300Information Provided by the Seller 300Information Available in the Public Domain 301Buyer’s Self-Assessment 302

Negotiating Strategies and Tactics 303Probing for Information 303Exploiting Discrepancies in the Seller’s Information 304Navigating the Seller’s Auction Process 305Creating the Single-Buyer Scenario 306Talking Price 307

xx Strategic Acquisitions

Trading Off Price and Terms 308Posture and Style 308Silence Is Golden 309Unique Attributes of the Buyer’s Off er 309Making Concessions 309Shadow Negotiations 31 0Stopping and Restarting Negotiations 31 0

Letter of Intent 31 1Usual Contents of an LOI 31 3

Binding Provisions 31 4Non-Binding Provisions 31 4

Buyer Deposits and Break Fees 31 7Expressions of Interest 31 8

Negotiating the Purchase and Sale Agreement 31 8

Conclusions 320

SECTION VI Due Diligence 323

Introduction 323

Due Diligence vs. Target Company Analysis 324

Primary Objectives of Due Diligence 325Verify Key Facts and Assumptions 326Identify Hidden Liabilities and Issues 326Identify Transition and Integration Risks 328Refi ne the Valuation and Pricing Analysis 329Refi ne the Integration Plan 329

Due Diligence Team 330

Components of the Due Diligence Investigation 332Revenue Base and Growth Prospects 333Management and Employees 334

xxiTable of Contents

Sales and Marketing 335Operations 336Historical and Prospective Financial Results 337Legal Due Diligence 342Timeline for the Due Diligence Investigation 344Staging the Due Diligence Investigation 344Asset Deals vs. Share Deals 345

Dealing with Adverse Due Diligence Findings 346

Conclusions 349

SECTION VII Closing 351

Introduction 351

Purchase and Sale Agreement 352Terms and Conditions of Payment 353Purchase Price Adjustments 354

Between the LOI and the Purchase and Sale Agreement 354Between the Purchase and Sale Agreement and the Closing Date 356Post-Closing Adjustments 356

Representations and Warranties 359Dispute Resolution 362

Other Agreements with Selling Shareholders 363Management Contracts 363Consulting Contracts 366Non-Competition Agreements 366Non-Solicitation Agreements 368Shareholder Agreements 368

Need for a Shareholder Agreement 370Unanimous vs. Ordinary Shareholder Agreements 370Decision Making 371Put-Call Provisions 371

xxii Strategic Acquisitions

Valuation Provisions 373Restrictions on Transfer and Rights of First Refusal 375Drag-Along and Tag-Along Rights 376Arbitration Clauses 376

Final Closing 376

Why Deals Fail to Close 377Diff erent Expectations 377Due Diligence Findings 378Adverse Change in the Target Company’s Operations 378Changes in Demands by the Seller 379Buyer’s Inability to Satisfy Conditions of the Off er 380External Circumstances 380

To Salvage the Deal or Not 380

Conclusions 381

SECTION VIIIIntegration 383

Introduction 383

Keys to Eff ective Integration 384

Integration Plan 385Execution 388

Managing Change 388Cultural Considerations 389Integration Team 390Communication Strategy 391Business Systems Integration 392Impact on the Existing Business 392

Feedback 392Control 394

Issues with the Seller 394Employee-Related Issues 395

xxiiiTable of Contents

Customer-Related Issues 396Operational Issues 397

Post-Mortem Review 397

Keys to a Successful Corporate Acquisition Process 400

Common Buyer Mistakes 402Corporate Strategy Development 402Searching for Target Companies 402Target Company Analysis 403Valuation and Pricing 403Negotiations 404Due Diligence 404Closing 405Integration 405

Conclusions 406