Lesson 8 - Business Pricing And Open Market Transactions

Question 1

Overview of Business Pricing

What are the key differences between notional fair market value (“FMV”) and open market price paid in an actual transaction:

Answer 1

• Parties are not always fully informed and acting prudently
• Parties are not always acting at arms length
• Markets may not be open and unrestricted
• Parties may be compelled to transact

Question 2

FMV is usually based only on

Answer 2

Intrinsic (stand alone) value

Question 3

In addition to intrinsic value, price often includes “post acquisition economic value added” (i.e. “Synergistic benefits”) This component

Answer 3

Of the price is unique to every individual purchaser.

Question 4

Identifying and Quantifying Synergies

Special purchasers are purchasers that are

Answer 4

Able to enjoy synergistic benefits by combining their existing business with the business they have purchased.

Question 5

Identifying Special Purchasers

Answer 5

• Discussions with management
• Analysis of competitors, suppliers and customers
• Analysis of information pertaining to recent transactions

Question 6

General categories of synergistic benefits:

Answer 6

Tangible:
Increase in EBITDA through increased revenues and or cost cutting

Intangible:
Reduce discount/capitalization rate through reduction of business risk and enhanced long-term growth opportunities or strategic advantages.

Financial:
Reduce discount/capitalization rate due to lower cost of debt and equity financing

Question 7

1st Place to look for synergies:

Answer 7

Marketing:

• Increase in market share
• Elimination of a competitor
• Improved market coverage
• Open up new distribution channels for existing products

Question 8

2nd Place to look for synergies

Answer 8

Operations:

• Technology transfer
• Offset seasonality/cyclical nature
• Improved capacity utilization
• Increased purchasing clout

Question 9

3rd Place to look for Synergies

Answer 9

Financial: Better access to lower cost financial resources. Larger size generally means lower cost of debt. If large enough, private equity placements and public equity markets. (IPO) may be available.

Question 10

4th Place to look for synergies:

Answer 10

Strategic:

• Reduction of risk from better product diversification and upstream and downstream integration possibilities.
• Entry into new strategically important markets

Question 11

Don’t forget transaction and integration costs:

Answer 11

Direct costs of doing the transaction (professional fees, management time and incidental costs)

Severance costs and turnover key personnel

System integration costs

Employee training

Facility disposition costs

Income tax costs

Question 12

Other Factors That Influence Market Price - Other forms of consideration

What is a vendor take back?

Answer 12

Vendor effectively finances all or a significant part of the transaction. Paid over time and include promissory notes and redeemable (or term) preferred shares.

Question 13

Other Factors That Influence Market Price - Other forms of consideration

What are earnouts?

Answer 13

A portion of the price is contingent upon the future performance of the acquired business. Effectively shifts a portion of transaction risk from purchaser to vendor.

Question 14

Other Factors That Influence Market Price - Other forms of consideration

What is a share for share exchange?

Answer 14

Common when the purchaser is a public company or is close to doing an IPO.

Question 15

Other Factors That Influence Market Price - Other forms of consideration

What is management or consulting contracts?

Answer 15

Vendor “stays on the payroll” of the acquired business for a period of time after the closing. In addition to bridging the price gap, these contracts can help in the transition of the business to the new owner.

Question 16

Other Factors That Influence Market Price - Other forms of consideration

What is a retention of a portion of shares by the vendor?

Answer 16

Often coupled with a “put option” held by the vendor of the retained shares

Question 17

Conduct of Negotiations

What is the vendors perspective?

Answer 17

Degree of vendor’s desire to sell
Vendor’s knowledge of the industry and other potential purchasers
Number of interested and financially capable buyers in the market
Vendor’s awareness of purchaser’s possible synergistic offerings
Uniqueness of vendor’s business operations and product offerings
Level of flexibility of the vendor regarding the purchaser’s financing of the transaction

Question 18

Conduct of negotiations

What is the purchaser’s perspective?

Answer 18

Ability to quantify synergistic benefits
Reliance of the purchaser on non-cash forms of consideration
Depth of knowledge of both the business and the vendor’s motivations to sell
Purchaser’s perception of likely competitive bids for the target business
Other investment opportunities open to the purchaser
Purchaser’s hurdle rate of return and the purchaser’s flexibility with respect to that rate

Question 19

What is due diligence?

Answer 19

Process of investigating, assessing and verifying information provided pertaining to the target business.

Question 20

What is the first function of due diligence?

Answer 20

1. Investigation/assessment:

• Developing an understanding of the business
• Assessing the risk of the acquisition
• Identifying opportunities
• Developing a pricing model based on results of assessment

Question 21

What is the second function of due diligence?

Answer 21

Verifification:

Ensuring that the purchaser receives the quantity and qualify of assets and liabilities that were anticipated in the agreed upon price.

Question 22

What does the investigation stage of due diligence involve?

Answer 22

• Clarification of purchasers strategy
• Industry review
• Business review
• Assessment of management
• Analysis of financial information
• Definition of risks

Question 23

The verification stage of due diligence involves applying professional _____________.

Answer 23

Skepticism. No information should be accepted at face value and all information must be weighed in some manner for reasonableness.

Question 24

What two agreements are often required before due diligence can begin?

Answer 24

Confidentiality and non-disclosure agreement.

Question 25

Preparing a business for sale

There are various steps that a vendor could take to make the business interest more attractive and/or more affordable to potential purchasers:

What is step 1?

Answer 25

Cleanup the financial statements:

• Extract redundant assets
• Consider removing real estate assets
• Remove shareholder receivables/payables
• Update off-balance sheet items such as leases
• Normalize income statement items:
  Excessive salaries, non-arms length management fees, unusual or non-recurring items

Question 26

Preparing a business for sale

There are various steps that a vendor could take to make the business interest more attractive and/or more affordable to potential purchasers:

What is step 2?

Answer 26

Operational review

• Update plant and equipment
• Update information systems
• Review management structure

Question 27

Preparing a business for sale

There are various steps that a vendor could take to make the business interest more attractive and/or more affordable to potential purchasers:

What is step 3?

Answer 27

Corporate housekeeping

• Cleanup outstanding litigious matters and contingent liabilities
• Update corporate records
• Pull together all major contracts, leases, and insurance policies

Question 28

Preparing a business for sale

There are various steps that a vendor could take to make the business interest more attractive and/or more affordable to potential purchasers:

What is step 4?

Answer 28

Prepare primary information package:

History of company, reasons for selling, opportunities, description of current operations, nature of product and services, market and competition analysis, customer and supplier profile, capital asset description, organizational chart, employee base, union details, summary financial information (historical and prospective), brochures and marketing materials.

Question 29

Preparing a business for sale

There are various steps that a vendor could take to make the business interest more attractive and/or more affordable to potential purchasers:

What is step 5?

Answer 29

Timing of the sale

• Considers industry and other external factors
• Cyclical nature of the business