The funding market was challenging during the back half of 2022 and expectations are that trend will continue in 2023. With cash running short and funding abundance running dry, there are many voluntary and involuntary exit strategies that should be considered this year. In anticipation that your company could be a target for merger and acquisition (M&A) activity, it is prudent to be prepared to maximize the chance of a close if a deal would be in the best interest of your company. There are few things that you can do to be best prepared for acquisition conversations.
M&A activity typically sparks positive reactions in business conversations, but in this kind of environment, it can be fickle in discovery and brutal in execution. Taking a step back and evaluating your current business model is the first exercise to conduct. Your main considerations will primarily have been about running the business on a day-to-day basis but it will be important to take a step back and look at your company from an external perspective. It is critical to understand and have a realistic argument for why your company would be an attractive target for an M&A deal – and that can be sobering.
It is critical to understand and have a realistic argument for why your company would be an attractive target for an M&A deal – and that can be sobering.
Did you underestimate your sales cycles, are your unit economics upside down, is your business undercapitalized, do you not have the right team in place anymore, did you overestimate your ability to attract customers? Honestly articulating why an acquisition is the best exit for you can help identify potential interest points that make your company a compelling target for buyers with the right synergies to leverage your current position. Is your company likely to be a strategic purchase (preferred) because of your customers, its brand, and synergies, or more of a financial one because of your team and product? What is your unique value proposition to any buyer or to specific types of buyers? Knowing the realities of your company’s situation and where the value lies in it can help you in negotiations.
Modeling and projections are complementary components to the proper evaluation of your existing business. Cash is king – and especially so in challenging environments. That makes understanding the source and uses of cash particularly important right now. Spending some time to model this aspect of your business so you can understand what your runway looks like for continuing operations is critical. M&A transactions take time and you need to understand your ability, at a minimum, to maintain the business until a transaction closes. Examining methods of how to extend your company’s runway and the tradeoffs of doing so before engaging with a buyer will help you outline the parameters you need to work within. In addition to budgeting for key departmental and administrative expenses, you will want to get a bottom-up understanding of sales growth in your projections. Having a structured but flexible financial model that you can run key scenarios through and understand the financial impact of your business is a critical aspect of making significant business decisions regularly. It is also especially important when evaluating the optionality inherent in M&A activity.
What’s the best optimization of your business that you can achieve and maintain over at least a six-month period? Can you turn your business levers to their short-term maximum potential? It’s time to do some analysis of your business from that perspective. Are your costs of goods sold allocated properly but also favorably? Have you examined how to get the most out of your existing gross margin structure? What sales pricing and motions can you leverage to prioritize growth now? Is your internal personnel and cost structure properly allocated or can you find improvement by inserting controls and mitigating spend? Finally, are your financial and metrics reporting in order or do you need to do some structural review and tweaking? If you’re going to get a deal done and maximize its value, refining your business for optimization over a much narrower time window, in periodic sprints, can be particularly useful (but of course comes with tradeoffs).
4. Due Diligence
Of course no conversation about M&A preparation is complete without a discussion of due diligence. Collecting and reviewing all of your company’s documentation in terms of contracts, patents, liabilities, and agreements so that they are accessible and organized will save a lot of time and headache during deal execution. Due diligence activities can redirect a considerable amount of time and resources away from normal business activities, but advanced preparation can control and distribute those demands more favorably (and less disruptively) across your internal team. It’s also prudent to do a risk and repair assessment of your company’s tax, compliance, legal, and litigation situation so that there are no surprises. If there are any outstanding issues, course correcting before engaging with a buyer (or at least having a mitigation plan already under way) will generally be a better position to be operating from.
If there are any outstanding issues, course correcting before engaging with a buyer (or at least having a mitigation plan already under way) will generally be a better position to be operating from.
Finally, amassing all of that information and having it easily accessible in a digital data room is an efficient and effective way to then share that information with potential acquirers.
In this first installment of our M&A Considerations series, we’ve discussed major themes for sellers to consider in preparation for any interested third parties. These are actions that a seller can directly control which benefit them independent of whether or not there is any immediate purchasing interest. In our second installment, we discuss what a seller can proactively do to engage and develop interest from outside parties when prioritizing and pursuing an exit via merger and acquisition.