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“Knowing Something” M&A in a Minute ⏰ — Crawling Inside the “Lock Box” Structure (Part 1) If you’re enjoying my posts, please drop a comment and share with your friends! I’m aiming for clear and concise—with the goal of demystifying the jargon floating around the mergers and acquisitions (M&A) world. So what does a “lock box” have to do with an M&A deal 🤔 My friend and partner, Jennifer Thiem, recently asked me to crawl inside the lock box and figure it out…and her wish is my command! So, let’s talk about it… In most private company deals in the US, the purchase price is based on a “cash-free, debt-free” structure with an up or down working capital adjustment thrown in for good measure. 💡 The idea is that the final purchase price will reflect the value of the business on the closing date—not necessarily when the deal is signed. Also implicit in this approach is that the seller is operating the business for its benefit and risk during the pre-closing period. For example, if there’s more cash or working capital at closing than expected, the seller receives that benefit. But if working capital declines or debt increases, seller is responsible for the shortfall. In order to make this happen, acquisition agreements set up a detailed process in which the buyer makes an estimated payment at closing and that amount is then “trued up” after closing to account for actual closing date levels of cash, debt, working capital, etc. ⚠️ The downside is that all of this has to be reflected in the agreement and then the numbers finalized after closing. This injects a level of uncertainty into what the final purchase price is and when it will ultimately be determined. But there’s another way to structure deals ⬇️ 💡The “lock box” structure flips the scrip and fixes the final purchase price at signing (i.e. “locks the box”) and then obligates the seller to operate the business for the buyer’s benefit and risk during the pre-closing period. Sounds a little crazy, right? Well, this “lock box” structure is commonly used in European deals and we’re seeing more of it in the US (or at least discussions around it), particularly in auction settings and in deals where speed and finality of purchase price are particularly important. 💡And, if you think about it, virtually all deals with a public company target are essentially “lock box” structures with a fixed equity price at signing and no adjustments for changes in working capital during the pre-closing period. Tune in tomorrow for Part 2 and let’s uncover how this “lock box” actually works…. ______________ If you like “Knowing Something” M&A in a Minute ⏰, please click the 🔔 at the top of my profile so you don’t miss any new posts! #mergersandacquisitions #mergersacquisitionsdivestitures #klgates #leakage #lockbox

"Because of the multiples that you're paying, you just can't count on making six acquisitions, slap them together, and hopefully buy them at an eight multiple and sell it at 10 multiple, because now you've got a business that's doing EBITDA of $20 million, and before it was $10 million. That model doesn't work." MERK Capital Corporation Corp.'s Thomas Parro on how today's economic conditions are affecting buyers' approach to deals. #chicago #dealmakerschicago #buying #mergersandacquisitions Read the full article: https://lnkd.in/g25G_dHA

Be Realistic About Add-Backs! EBITDA add-backs are an important part of the M&A process. Buyers and sellers should keep the purpose of add-backs in mind as they negotiate: Arriving at an accurate valuation of the business. Sellers may be tempted to push for as many add-backs as possible to drive up valuation but that's the wrong approach. A common example is wanting to set yourself a super low go-forward salary to maximize the add-back and the EBITDA. Don't do it; it will slow down or even derail deals. The goal should always be to act with integrity and have that honest dialog between buyers and sellers. To this end, sellers should identify their legitimate add-backs before negotiations begin, including a market-based salary for your go-forward responsibilities, and they should be prepared to justify them in detail when the time comes. For example, if you're going to be leading sales post-close, you shouldn't plan to reduce your comp to $50k (from the current $200k) just to juice the EBITDA by $150k. The head of sales, in any normal business, doesn't make $50k! Experienced buyers understand legitimate add-backs and will appreciate the additional clarity they bring to the valuation process. #MergersandAcquisitions #BusinessSale #Exit #Ntiva

One of the most important questions during Merger Model ! •How can you tell whether a deal is accretive or dilutive? Concept: An M&A deal is accretive if the combined company's EPS (earning per share) is higher than the buyer's standalone EPS prior to the translation. It is dilutive if the combined EPS is lower, and neutral if the EPS is the same afterward. Outcomes depends on price paid for the seller, method of payment (cash, stock, or debt), the intrest rate on debt and cash, and the buyer's P/E multiple, among other factors. In real life, very deficult to tell whether it will be accretive or dilutive without running the whole model- due to add cost, synergies, write-ups, timing differences, cumulative impact of additional interest on debt and foregone interest on cash, etc. But we can approximate the impact with a simple rule of thumb:- 1. Calculate the weighted “cost" of aquisition for the buyer, 2. And compare it to the seller's “Yield" at its purchase price, i.e. (Seller's net income/Equity purchase price) 3. If the seller's “Yield" is higher, it's accretive otherwise - If it's lower it's dilutive. How to calculate the weighted cost of aquisition? Answer- Need to calculate after tax “cost" of each component, since net income is also after tax. After-tax cost of cash = foregone cash intrest rate * (1- buyer's tax rate) After-tax cost of debt= intrest rate on the debt * (1- buyer's tax rate) After-tax cost of issuing stock= 1/Buyer's P/E multiple That last one is effectively the buyer's after tax “Yield". For example, If you buy a share of the buyer's stock, that is the net income you'd be entitled with that one share, so here, buyer's P/E multiple = 8.9% Meaning that each dollar of USA'S stock you but, you get $0.089 in net income. therefore weighted average= cost of cash * % cash used + cost of stock * % stock used + cost of debt * % debt used. So this is the answer of the question, Yes there is a few limitations in this method but you can approximate which will be accretive or which will be dilutive deal. If you find it important then like this and follow me PRAFULL RATURI for more premium finance content. Thanku, have a great day. #finance #investmentbanking #mergersandacquisitions

On the surface it seems simple. The definition of “fair market value” is the price at which a willing buyer will buy and a willing seller will sell, in an open market, where the parties are at arms-length and not related to each other. But what if a portion of the value is based, not on past performance, but on future earnings? Valuing the likelihood of future earnings growth is always challenging but especially so in the context of business acquisitions. Sellers may overestimate future earnings, while buyers may be unwilling to pay for earnings that may prove ephemeral. In many instances, the solution is an “earn-out” – the transactional equivalent of putting your money where your mouth is. Earn-outs provide for additional, post-closing payments to sellers based on fulfillment of conditions or financial objectives specified in an agreement. Earn-outs are a common technique in business transactions, and understanding their risks and rewards can help to avoid post-closing problems.

Good advice right here.

On the surface it seems simple. The definition of “fair market value” is the price at which a willing buyer will buy and a willing seller will sell, in an open market, where the parties are at arms-length and not related to each other. But what if a portion of the value is based, not on past performance, but on future earnings? Valuing the likelihood of future earnings growth is always challenging but especially so in the context of business acquisitions. Sellers may overestimate future earnings, while buyers may be unwilling to pay for earnings that may prove ephemeral. In many instances, the solution is an “earn-out” – the transactional equivalent of putting your money where your mouth is. Earn-outs provide for additional, post-closing payments to sellers based on fulfillment of conditions or financial objectives specified in an agreement. Earn-outs are a common technique in business transactions, and understanding their risks and rewards can help to avoid post-closing problems.

“Knowing Something” M&A in a Minute ⏰ — Crawling Inside the “Lock Box” (Part 2) Here’s the drill: I’m aiming for clear and concise—with the goal of demystifying the jargon floating around the mergers and acquisitions (M&A) world. So what does a “lock box” have to do with an M&A deal? Well, if you missed Part 1, what are you waiting for?!? I’ll link to it in the comments. But first, let’s get some jargon out of the way👇 Lock box date—the “lock box date” is a date close to signing at which the parties agree to the final value for the business after adjusting for cash, debt, etc. In effect, the deal is priced like a public company transaction as of the lock box date. Because the seller is now running the business for the benefit and risk of the buyer from the “lock box date” to the closing date, there has to be some restrictions on seller, right? ⛔️ Beware of leaks! If the seller allows “leakage” (which are unpermitted payments or other benefits flowing to the seller—like dividends) or incurs additional debt, then buyer gets compensated through a purchase price adjustment. Keep in mind, this isn’t meant to adjust value so much as to be protective and typically “leakage” is expected to be zero. Finally, since seller is now effectively running the business for the economic benefit of buyer, some enterprising (and well-advised sellers) may want to be compensated through “ticking fees” that provide incremental value if closing is delayed. Ok, so when is it a good idea to use a lock box structure in a deal? ✅ deals where the approach is to price similar to a public company transaction and value the business based on an equity basis as opposed to enterprise value ✅ deals where either the buyer, seller, or both want to emphasis price certainty and potentially reduce post-closing friction (such as in PE sponsor sales, auctions, and public style “no recourse” deals) ✅ the parties are struggling to fix a closing working capital peg as a result of a long pre-closing period or there have been extraordinary swings in working capital or external events in the trailing period ✅ deals where the target has clean, audited financials and no concerns regarding accuracy and transparency (remember that the box is being locked and the deal priced as of a pre-signing date and so reliance on good financials is key) 💡Overall, there can be some real benefits (valuation certainty, smoother process, less wrangling over over capital target, etc) to using a lock box structure for both a buyer and a seller. But to get it done right requires some thought and care and a willingness to “step outside the box” 😉 and try something different. Yep, I just did that! So tell me…what’s been your experience with lock box structures? _______ If you like “Knowing Something” M&A in a Minute ⏰, please click the 🔔 at the top of my profile so you don’t miss any new posts! #mergersandacquisitions #mergersacquisitionsdivestitures #klgates #lockbox

In M&A transactions, earnouts serve to synchronize the expectations of both buyer and seller by connecting a segment of the acquisition cost to the future performance of the company. Read our blog to learn what factors must be considered to craft an effective earnout structure. #brentwoodgrowth #businessvaluation #businessforsale

Why a buyer must recalibrate his #mergersandacquisitions decision? When we say #valuation, our focus always shifts to the #DCF/Income approach. In reality, a buyer will value an equity investment in a business using the 'Market Approach,' focusing specifically on multiples like EBITDA to determine the enterprise value. For instance, a buyer acquires a target for $500 𝐦𝐢𝐥𝐥𝐢𝐨𝐧, 𝐜𝐨𝐦𝐩𝐫𝐢𝐬𝐢𝐧𝐠 $200 𝐦𝐢𝐥𝐥𝐢𝐨𝐧 𝐢𝐧 𝐞𝐪𝐮𝐢𝐭𝐲 𝐚𝐧𝐝 $300 𝐦𝐢𝐥𝐥𝐢𝐨𝐧 𝐢𝐧 𝐝𝐞𝐛𝐭. Industry median multiples were 8X LTM and 7X forward EBITDA. The target outperformed at 10𝐗 𝐚𝐧𝐝 8.33𝐗, 𝐫𝐞𝐬𝐩𝐞𝐜𝐭𝐢𝐯𝐞𝐥𝐲. The Last Twelve Months (LTM) EBITDA was $50 million, and forward EBITDA was $60 million. Fast forward six months, and we see the target's LTM EBITDA improved to $55 million while its forward EBITDA jumped to $64 million. The industry's median multiple for LTM EBITDA improved from 8X to 9X, suggesting a healthy industry outlook. With this new data and taking into account adjustments for market conditions, the buyer reassessed the enterprise value at $560.75 million. After accounting for the increased debt value of $304.5 million, the total equity value was found to be $256.25 million. 𝐖𝐡𝐚𝐭 𝐝𝐨 𝐢 𝐰𝐚𝐧𝐭 𝐭𝐨 𝐬𝐚𝐲? [1] First, the initial higher valuation compared to the peers suggested the buyer expected this company to outperform during the due diligence. [2] Second, the equity value saw a 𝐫𝐞𝐦𝐚𝐫𝐤𝐚𝐛𝐥𝐞 𝐠𝐫𝐨𝐰𝐭𝐡 𝐨𝐟 28% 𝐢𝐧 𝐣𝐮𝐬𝐭 𝐬𝐢𝐱 𝐦𝐨𝐧𝐭𝐡𝐬, from $200 million to $256.25 million, signaling the potential for high returns. [3] Third, this valuation isn't set in stone; it's recalibrated over time based on both market data and the company's performance. So, as a buyer, you must recalibrate your acquisition post-closing to understand whether you have bought the company at the right price and whether you understood its growth prospects properly while giving an offer price. Two things happen in this example - the industry you are betting for M&A is growing and the target is outperforming the industry growth. As a next step, you must communicate your calibration results to your shareholders at quarterly results or at least to your board so that they can understand your deal execution capabilities along with synergies realization ability.