In this time of increasing M&A activity, I am excited that ESOPs and other middle-market companies can benefit from the National Center for Employee Ownership’s newly released M&A guide, which is broader in scope than its previous handbook. Several of my colleagues and I contributed to the NCEO on this issue, and it reflects our collective experience advising ESOP companies on literally hundreds of transactions.
The chapters we prepare detail the fundamentals of mergers and acquisitions as a business strategy, the steps that are likely to result in successful M&As, and the central factors in structuring and financing deals. While the guide includes substantial content and countless details, behind what we write are five high-level truths. [ OR takeaways] that ESOPs considering mergers and acquisitions should keep in mind.
Know yourself. It is vital that the ESOP company’s board of directors and management team understand why they pursue mergers and acquisitions as a strategic tool. Generally, the impetus is to grow faster than the company can grow organically. They must be confident that acquisitions are the best growth strategy at this stage of their company’s life cycle.
A detailed acquisition strategy is essential to identify opportunities that create long-term value. These do not develop overnight and are often part of a company’s multi-year planning process.
For example, Border States, an employee-owned electrical and industrial distributor that we advise, builds long-term relationships to generate deals rather than relying solely on brokers to identify potential acquisition opportunities, and the majority of its acquisitions reflect the cultivation of that relationship.
And Proponent, a global aerospace and aircraft parts distribution ESOP that we advise, employs two pillars of strategic acquisition: expanding its product portfolio and increasing its geographic presence.
Given the risks (acquired growth is inherently riskier than building from within, plus the significant time involved), don’t get carried away with M&A. Too often, a company’s M&A process begins only when an investment banker comes along with a potential acquisition and seeks to engage the ESOP in a competitive auction process.
Comply with the process. Executing a successful M&A strategy will include a process for generating targets, another for scoring and comparing them, and an approach for completing due diligence.
A word about goals: The most successful buyers don’t wait for the phone to ring. They build deliberate relationships with potential acquisitions long before they are ready to sell and embed this mindset throughout their management team.
Prior to its first acquisition, for example, Hypertherm – a manufacturer of industrial cutting systems and software that we helped become an ESOP – identified significant growth opportunities in underserved market segments globally. Having its ear close to the ground allowed the Hanover, NH, company to be more proactive than reactive and find companies outside the United States for half of its publicly announced acquisitions.
As objectives are presented, a successful research effort involves defining ideal characteristics, ranked from most to least compelling, and using these criteria to rank potential opportunities. If a target company passes this evaluation, ESOP management and its advisors will complete a preliminary evaluation to determine whether the acquisition is strategically logical and financially viable. This usually involves a confidentiality agreement that allows for the sharing of critical information.
If the ESOP decides to proceed, management works closely with legal and financial advisors to negotiate and fund the deal, first executing an indication of interest and then a letter of intent. The latter indicates how much the ESOP intends to pay for the target, how to pay for it, and other critical considerations the seller should be aware of. At this point, due diligence, deal structure and document preparation, and financing begin in earnest. Recognize at this stage that management’s time commitments are more intense and the risk of delay or process failure is greater.
To realize the benefits the deal is intended to achieve, the ESOP will want to develop a solid integration plan to execute with the management of the acquired company once the deal has closed.
Being the buyer sets a very high bar. While being an ESOP is often attractive to sellers, it is imperative to take advantage of the ESOP. ESOPs are often attractive in terms of their superior culture and employee engagement, so management must know how to tell their ESOP story well. Acquisitions consist of both the buyer selling itself to the target and the target company selling itself as an added value to the buyer.
At the same time, the obligation to create value for employee shareholders is a responsibility that is of great importance to ESOP management, its board of directors and its administrator. It is essential to help the trustee understand the fairness of the transaction and, if your target is another ESOP, to help the trustee understand this for its employee shareholders as well.
Enjoy the financing options available. They are more abundant than ever for ESOPs. Historically, senior debt from a commercial bank in the form of a revolving credit agreement or term loan was the only source of financing for ESOPs and employee-owned businesses. But the spectrum of non-bank financing alternatives for middle-market companies has expanded dramatically over the past decade. While commercial banks remain the primary financiers of new and existing ESOPS, non-bank lenders, mezzanine debt funds, structured equity and even minority equity now compete with traditional bank borrowing as alternative sources of growth capital, including for acquisitions.
Seek help. Especially if this is the ESOP’s first transaction. The complexities of due diligence, deal structuring and financing make it very important to retain experienced legal, financial and accounting advisors who work together effectively. The seller will almost certainly be represented by an expert attorney.
Looking at the landscape, ESOPs today do a better job of explaining why the structure makes them the right choice for sellers. We are also seeing more rational pricing for PE companies and sellers who are increasingly looking at ESOPs as potential buyers, all factors that favor ESOPs as buyers.
As ESOPs increase their experience, capabilities and confidence in M&A, I am sure we will see many more acquisitions by them, helping to make this, as I have long anticipated, the Decade of ESOPs.
