Acquisitions & HubSpot (the Pre IPO Company)

As a company prepares for an IPO it needs to review its key processes to ensure fitness for purpose. I rarely see Acquisitions as part of the processes reviewed and yet they are one of the key tools to help scale the post IPO business. So if I was HubSpot I’d take this opportunity to take a long hard look at my Acquisition Process before the lights and cameras are turned on in the Public Company world. Here is my ultimate cheat sheet for Acquisitions. I’ve divided my Acquisition Approvals Model into six phases with a key approvals stage at the end of each phase. Six phases are Strategy, Target Identification, Assessment of Target & Price, Negotiate Price & Structure, Legal Completion, Post Completion. The order is important.

STRATEGY

Develop Strategic Direction – I can’t stress enough the importance of understanding who you are, what your core competencies are, because getting that wrong can be fatal. You need to be damn sure you can integrate the target and that you can run it better than the seller. Remember you are not just buying the house you are buying the family inside it! You want to buy what you want to buy not what is up for sale. Acquisitions are just a tool of strategy not a strategy.
Produce Acquisition Profile – This is your shopping list of poster children. The targets you would like to buy, not names but ideal characteristics.
Quick & Dirty Search – It is important to check quickly that targets exist that match your precise shopping list. e.g. one initial acquisition profile described an IT Governance software company with sales in excess of $50m in a geographical region and produced zero targets. Think again. Or a generic set of characteristics for distribution companies produced 1000′s of candidates – refinement clearly was needed.
Acquisition Profile Agreed -Therefore it is now possible to sign off on a measured shopping list which reconciles to an attractive strategy with sufficient initial targets.This profile is a powerful document.
Health warning: This phase can take weeks or months to get right but you can see the measured preparation that went into that. You are forcing management to consider post acquisition integration and fit with the current core business right out the blocks! Instead of looking all starry eyed at what is for sale you are ripping the emotion out of the process and focusing on the type of companies that fit well inside your comfort zone.

IDENTIFY TARGETS

Team Selection: Each type of acquisition deserves a separate team. Project lead (could be the Corporate Development Director), key financial/metrics champion, domain expert, sales and marketing specialist, technical expert.
Identifying Targets: The acquisition search process has been transformed over the last 10 years as information increasingly comes online. That said, tips for places to look for target names –

Private Equity portfolio company lists.
Trade shows attendee companies.
Inc. 5000 list.
Software 500 list.
Gartner sector reviews, Hoovers, Keynote, Dunn & Bradstreet, American City Business Journals, Ward’s Business Directory.
All sectors/segments have trade bodies with members.
Your own sales teams, technical staff, marketing teams (assuming it is not confidential).
Influencers, lawyers, accountants, suppliers are all capable of generating ideas.

Collating Key Facts: I suggest pulling this together in three strands, market intelligence, target info non people and people. Remember this is just the initial gathering of key facts on priority targets. Detailed due diligence covering a plethora of subjects comes later

Market information should include all the key players, relative size, USPs, key trends, forecasts, threats and opportunities. Ask yourself what would an investor need to know if you were summarizing the market and the companies within it.
Target information on each target needs to include (and this will not be easy for private companies):
Shareholders
Sales for the last 5 years
# of employees
Profitability if known
Main products/services and key business results each target delivers for their customers
Key customers
Office locations
Awards
Sales channels
Press Coverage
Social Media summary
Estimated market share
People information should include:

Organization charts
Bios of the management team
LinkedIn profiles of key staff
Google results of key staff
Technorati ranking of their blogs, twitter rankings, social media ratings

Briefing Papers & Mandates: These key facts will then be pulled together to allow you to do several things:

Assess an initial post acquisition fit e.g. there might be immediate client conflict revealed, geographic fit might be excellent.
Start to prioritize the target list based on facts not emotion.
Build briefing papers on priority targets to seek a mandate from your Board to contact targets.

Craft an insightful script for target contact.

ASSESSMENT OF TARGET AND PRICE

Psychology Prior to Contact: The most sensitive subject in these discussions is often price. Remember the following tenet will serve you well: Buyers perceive value, sellers aspire to price.
Health warning:Each buyer has a unique footprint that they stand in as they assess value. One buyer may have a comprehensive distribution channel and therefore have limited use for your sales overhead – think Oracle, IBM, Pfizer. The opposite may be the case where the buyer welcomes your unique reach into say, the SMB marketplace and needs your distribution channel. Thus only a buyer is capable of calibrating a unique value to them of owning the target business.
The seller on the other hand is aspiring to price. It’s not the sellers money that’s paying for the deal. The seller might be the majority shareholder and CEO and is being influenced by the proceeds her friend achieved from selling her business, or she may be driven by replicating ten years worth of annual income. She is aspiring!
Contacting Targets: Clearly if there is already a relationship with the seller then reaching isn’t too difficult. However if there has been no prior contact consider:

Consider cold calling the owners, principal to principal.
A well-written letter to the owner’s home address can be effective.
Using an intermediary can also be effective but I would recommend the buyer’s name be revealed.

Assuming this contact is successful then acquirers need to prepare for this first meeting. If unsuccessful, please write to the owners expressing keen interest to follow up if circumstances change at a later date.
Strategic Fit – detailed role playing

Pull together all the key facts and rehearse obvious questions that you will be asked in this first meeting including; your ability to finance a deal, the strategic fit, the post acquisition plan, the role of the seller’s management. Rehearse your answers as a conversational style rather than as answers to a questionnaire!
You will be asked how much you are prepared to pay. Resist this temptation by explaining that you do not possess enough facts to assess value and that a full disclosure of the facts allows acquirers to place a full value on attractive companies.
Acquirers need to send the signal that they are professional, reliable people who treat people fairly.

Target Meetings: By doing your homework you are entering these meetings in a relaxed state of mind but make no mistake, negotiation has begun. Pointers:

Impress the seller with your knowledge of the market and the sellers competitive positioning in the marketplace.
Frame the landscape of why you believe there is a fit and your outline thought for growth.
Explain the types of facts you need to gather to assess the potential post acquisition plan and therefore the value to the acquirer of completing a deal.
As a helpful checklist of the questions you need answers to it might be helpful to study both my paper on valuation mentioned above and a previous post on post acquisition integration.

Investment Paper to Seek Price Mandate: The culmination of this work will be a Board Paper seeking a mandate to negotiate a deal. This paper allows the Board to review the facts and assess the strategic and financial benefits of a deal. (far better to abort now than at the last minute prior to legal completion). Think of the audience as a cynical non-executive independent director. What to include:

The mandate should articulate the pricing range and key commercial conditions required. Be careful to give yourself some wiggle room. A single price can be too constraining.
Set out the logic of the price including:

Profits adjusted to reflect your ownership
Multiples used -PE basis
If an earn out deal is proposed, highlight the initial PE and demonstrate that exit PE is lower when the earn-out completes
Previous deals done in the industry with prices & multiples paid
Highlight specific savings if any you are building them into the logic
Highlight the ROI

Articulate at a high level the essence of the post acquisition strategy.
Articulate the strategic case for the deal – see post on Justifying Acquisitions.

By taking this approach you are dealing with two key behaviors of successful, practiced acquirers:

Do you really want to do this deal, does it makes sense because its much cheaper to exit now than later
If I want to do this deal, then before I enter final negotiations on price, I know why I’m doing the deal and what’s its worth to me and only me.

NEGOTIATE PRICE & STRUCTURE

At this stage of an Acquisition you are entering a dangerous phase of emotional attachment. Be careful to continue auditing the signals.
You have signed off a price mandate with your Board, you have a post acquisition plan on paper and now you need to enter this final phase of negotiation confident of the type of deal that works for you. It is unlikely that you have reached a preferred bidder status so this phase is all about getting to that preferred, exclusive status or walking away.
Meet with Target to clarify key facts: Prior to a final Heads of Agreement meeting I would recommend a more informal meeting to clarify a bang up to date situation on these topics:

Latest full year forecasts
Current trading
New customer wins
New hires or resignations
Assets or shares being purchased
Any exclusions from the sale, assets, subsidiaries, patents
Personal objectives of the seller, price, service contract, role, promises he has made to staff etc.
Market and channel strategies
Status of pipeline
Status of cash flow
Any operational issue impacting on your post acquisition plan

Heads of Agreement Meeting: Assuming you feel, certainly pre formal due diligence, that you have all the key facts then move to a formal Heads of Agreement Meeting within a week. In a previous blog post, Negotiation Tips, I set out 17 quick tips to achieve great results for these types of meetings and specifically for Heads of Agreement Meeting I offer this agenda:

Update since last meeting: it is vital to clarify even at this late stage any change of information which affects the deal. I’ve seen dramatic events hit a business only days after a previous meeting.
Confirmation of what is included: it is possible that misunderstandings still exist especially private assets of the owners e.g. the Aston Martin.
Earn -out formula and period: too often in deals, due to time pressure or other reasons, earn-out deals are not clarified in sufficient detail through worked examples.
IPR: Acquirers must ensure that the relevant IPR is owned by the target company and not by individuals or companies outside the target group.
Removal of personal guarantees: the removal of these guarantees should be sold as a benefit of the deal but are often overlooked
Key warranties and indemnities: although an issue to be discussed in detail at the contract stage, it is a great opportunity to spell out the key ones the buyer will expect to see in place.
Purchase price and consideration: I would keep this down the agenda until you have achieved some momentum to the meeting. I would merely add this thought to previous thoughts on pricing, you should adopt a “no regrets” policy.You do not want to lose the deal by low balling only to see a competitor close the deal at a price you thought fair! On the other hand if the business is worth $30.5m to you then that’s it.
Exclusivity: as acquirer you want to establish an exclusivity or lock-out period to allow due diligence to take place without a competitive threat. 8 weeks is an acceptable exclusivity period to completion.

LEGAL COMPLETION

At this stage you want to ensure that all due diligence is completed, commercial, legal, technical. There are usually several parallel projects going along at the same time including the draft purchase contract.
It’s also a great time to complete all public announcements ready to go if the deal completes.
The post acquisition plan should be reviewed in detail by the project head and outstanding due diligence items flagged up. You should be constantly fine tuning your plan based on new facts as they arrive. Remember to break down your actions into immediate, first 30 days, 60 days, 90 days.
As an experienced lawyer once said to me – there are no legal points just commercial points. In other words when negotiations get tense and they will, always look for the commercial consequence surrounding the point under discussion.
When completion does finally occur I would recommend that the CEO of the acquirer should make an appearance to signal to the seller that the deal matters.

POST COMPLETION

I would highly recommend that the acquisition team meet as soon as possible post completion to review lessons learned. This one step has proven to be crucial to improved success according to all the merger research.