M&A Expert Value Creation Points -- #4, Building The CIM -- Investment Highlights

 

This slide needs to serve as a hook; it should highlight 2 or 3 things which compel the reader to continue through the meat of the document. That said, if a prospective buyer has reviewed the teaser and signed an NDA, they have already seen and responded positively to this information. At the bottom of the page, there is a graphical opportunity to hammer home the forward looking growth, revenue, and EBITDA highlights.

A basic outline should include:

  • Employee count, HQ location, and founding year;

  • Nature of the business;

  • Customer count and SaaS metrics (if relevant): LTV, CAC, and churn;

  • Market TAM statement, and market cycle phase and growth trend;

  • Explanation over growth limiters, typically the lack of outside capital;

  • Summary of technology platform;

  • Shareholder dynamics and capitalization

Some of the top highlights in this example are:

  • Full POS integration; although we've broadly anonymized this example, the solutions in this space must have POS integration as a matter of course, and for the additional benefit of channel sales;

  • Enterprise grade levels of churn @ 3%, and a high LTV:CAC ratio, suggesting an under-investment in growth (which is true for this company, never having taken on outside capital);

  • Sustained, high levels of recurring revenue growth;

  • Trend to must-have in a market with a defensibly large TAM;

  • Current technology platform base (Ruby on Rails);

  • Single shareholder with presumably nominal or low cost base

Want to keep reading? See Industry Trends, the next in this series.

M&A Expert Value Creation Points -- #4, Building The CIM -- Introduction and TOC

Think of the Confidential Information Memorandum as a storybook; a self-contained standalone narrative that reads front to back, and optimally reveals a company for its maximum expressible enterprise value. As sell-side M&A advisors with years of operating experience inside technology companies, we build the CIM document once we've done a full deep-dive with the executive and management; after we have gathered a comprehensive view each major functional area of the business from an insider's perspective: the underlying technology platform and architecture, the existing customer base, the management team, the financial history, and so on. We then endeavor to surface certain forward-looking pro forma aspects of company value, which range from the obvious, to the aspirational. The more obvious points might relate to things like projected next 12 month (NTM) financial performance, as supported by existing sustained customer acquisition based on historical growth. More aspirational points might tie to growth opportunities in new lines of business, geographic expansion, 'share of wallet expansion' for negative churn, or certain aspects of expected post-acquisition cost or revenue synergies. All of the financial points manifest in the bottom-up developed financial model which exists and is distributed as a companion to the CIM; therefore, one way to think of the CIM is as the Management Discussion and Analysis (MD&A) portion of the financial model, as if the financial model and CIM were presented together as a company's annual report as at the time of marketing the company for sale.

By way of illustration, let's dissect and break down the architecture of a typical CIM that we've used in the marketing of a recent enterprise software SaaS transaction, slide-by-slide.

Table of Contents

The TOC is straightforward. It's arguably unnecessary, as the CIM is meant to read cover to cover, but is helpful for later quick access to sections like the Financial Summary. Ensure the TOC is hyperlinked for easy navigation, regardless of which document format you elect for distribution (typically watermarked PDF, customized per interested party, post NDA).

Please see the next article in this series: Investment Highlights.

M&A Expert Value Creation Points -- #3, The Teaser

Private companies don't trade in an open market. Information, distribution, and discovery in the private company M&A market is a function of generally proprietary knowledge existing in personal networks, independent research, and databases that identify the target list of potential PE and strategic buyers. In Part 1 and Part 2, we talked about the process of building and expanding the target list and financial model, and the stand-alone value created through the associated creative thought and analysis. The Teaser plays a similar role in a sell-side M&A advisory engagement, the distribution of which marks the formal commencement marketing a business for sale.

Let's dissect the teaser we recently used in the marketing of a mid-market focused HR Technology payroll and time and attendance software company:

Subject: Project Anderson: HCM - Payroll SaaS company

Hi Peter,

Our investment banking firm is advising the company profiled below and I was thinking it might be a fit for your organization.  Please let me know if this is something I should follow up with you on, or if there is a more appropriate point of contact.

Thanks,

Andrew

Overview

» Human Capital Management - Payroll SaaS

» Canadian geography

» Mid to large organizations

» Diversified across industries

» 250 current customers

Base Case Financials (YE-Sep30)

 » 10% stable CAGR historically, accelerating growth in 2016/2017 (see growth drivers, below)  » Exceptionally low churn (<2% / year)  » 24% EBITDA margin and improving with scale.

» 10% stable CAGR historically, accelerating growth in 2016/2017 (see growth drivers, below)

» Exceptionally low churn (<2% / year)

» 24% EBITDA margin and improving with scale.

 

Growth Drivers

» On-premise customers moving to SaaS licensing

» Increased Canadian sales penetration outside HQ province

» Provide full payroll remittance services

» Expansion into U.S. or European markets

Modules

» Payroll & Benefits Administration

» Human Resources & Recruiting Management

» Time & Attendance

» Employee / Manager Web Self Service Portal (w/ iOS and Android mobile apps)

Technology

» 100% company owned intellectual property

» Built on Microsoft stack (.NET/SQL)

» On-premise and SaaS versions

» Moving hosting to Microsoft Azure

» Modular design –  individual modules can complement existing software

» Readily extended with tax/form engines to deliver payroll in other countries

Let's have a look at the greeting, again:

Hi Peter,

Our investment banking firm is advising the company profiled below and I was thinking it might be a fit for your organization.  Please let me know if this is something I should follow up with you on, or if there is a more appropriate point of contact.

First, we're using a relatively informal tone. We're identifying our role as sell-side advisor in an M&A process, and we're indicating to the reader that this is what is known as commonly known as a 'teaser' summary of the company that is for sale.

Next, we extract and hit on the key high points:

Overview

» Human Capital Management - Payroll SaaS

» Canadian geography

» Mid to large organizations

» Diversified across industries

» 250 current customers

This is a recurring revenue Payroll SaaS business, with Canadian customers, a mid-market focus, no particular industry concentration, and 250 current, active customers. Other than size, nearly all groups would at this point have enough information to filter the target on the basis of industry, fundamental nature (SaaS software), and geographic focus.

Next, we summarize the overall size of the target, as a function of historical and projected financial performance:

Base Case Financials (YE-Sep30)

 » 10% stable CAGR historically, accelerating growth in 2016/2017 (see growth drivers, below)  » Exceptionally low churn (&lt;2% / year)  » 24% EBITDA margin and improving with scale.

» 10% stable CAGR historically, accelerating growth in 2016/2017 (see growth drivers, below)

» Exceptionally low churn (<2% / year)

» 24% EBITDA margin and improving with scale.

This table succinctly conveys 3 things: 1) the overall size of the company, 2) the growth rate of the company, and 3) the profitability of the company. We can see from the figures that this target will be small for many PE firms, particularly those that have a minimum 'bite size' in excess of $10M USD (on the basis they are unlikely to pay 9X trailing EBITDA for a relatively low growth business). We do highlight 3 additional points: 1) that the business has achieved consistent, steady growth, 2) that the churn rate (rate of customer loss) is exceptionally low, and 3) that the business is profitable and enjoys positive operating leverage (the EBITDA margin is set to grow with revenue, as significant fixed costs prevail). At this point, many PE or strategic buyers will stop reading because the target self-excludes for a poor match relative to size and/or growth, or industry focus.

 

Next, we summarize our arguments for growth:

Growth Drivers

» On-premise customers moving to SaaS licensing

» Increased Canadian sales penetration outside HQ province

» Provide full payroll remittance services

» Expansion into U.S. or European markets

These are the foundational, stand-alone growth levers discussed in Part 2 of this series, listed in order of opportunity. In this case, the move from traditional on-premises licensing plus annual maintenance to full SaaS, and the success-to-date transitioning existing customers, represented by far the largest active growth lever. The next most obvious was the opportunity to increase sales penetration outside the home province; the penetration rate in other English speaking provinces was only 25% as high as in their home province, where their only salesperson was domiciled. Although a feature commonly offered by competitors, our client's business did not handle the direct remittance of government deductions due to trust account and fund handling liability concerns, which sometimes cost them deals. We assessed this to be a relatively straightforward opportunity to grow the customer base. Finally, we highlighted the opportunity to move outside Canada; we listed this opportunity last, because we recognized that payroll doesn't travel across jurisdictions well (the nuances vary too much, geography to geography), and because only a US payroll engine had been seriously assessed for integration by the team.

We describe the product modules as follows:

Modules

» Payroll & Benefits Administration

» Human Resources & Recruiting Management

» Time & Attendance

» Employee / Manager Web Self Service Portal (w/ iOS and Android mobile apps)

In the context of HCM / HRIS, payroll is easily understood. For a mid-market focused player like our client, there are other clear and complementary modules required by nearly every customer. And mobile is always key. We list those, here.

Finally, we provide a snapshot of the technology stack:

Technology

» 100% company owned intellectual property

» Built on Microsoft stack (.NET/SQL)

» On-premise and SaaS versions

» Moving hosting to Microsoft Azure

» Modular design –  individual modules can complement existing software

» Readily extended with tax/form engines to deliver payroll in other countries

We make the baseline and key assertion that there exists no reliance on outside, 3rd parties. We describe the base technology stack and technology choices, and discuss the extensibility of the platform.

A compelling Teaser that succinctly paints a picture of the target, and shines light on the potential for growth, is critical in the initial marketing of a private company for sale. If it's off key or poorly composed, response rates will suffer, and potential buyers may be lost. Post NDA, interested parties receive a full CIM and financial model, and are then offered a management meeting to dive in deeper and learn more.

M&A Expert Value Creation Points -- #2, Building the Model

A forward-looking pro-forma financial model is central to any buy or sell-side M&A process; it's the detailed, analytical assertion over future company performance, and therefore present enterprise value on a stand-alone, financial basis. Naturally, the rational buyers want to pay the least for any given target. In order to argue for the smallest figure, they typically start by suggesting that historical revenue growth will at best sustain, or even decline. Further, they typically argue against any major EBITDA margin deviations with increased revenue, and so aren't inclined to ascribe value to the prospect of any operating leverage. This is totally irrespective of what they consider to be the true post-acquisition cost or revenue synergies; they never want to pay for the value they intend to realize once a target is under their control, nor do they wish to tip their hand to where that value may exist in their own pro-forma analysis.

The counter weapon to these buy-side arguments is a fully articulated, triple statement, forward looking, pro-forma financial model. In order to build the revenue side of such a model, it's necessary to dig deep into a client's business, to understand the full spectrum of growth opportunities that exist. The identification of these growth levers is fundamentally value creating, because they must all be valid in case the company does not trade, and instead elects to continue operating independently. These are discovered through management interviews, market research, and the application of our broad experience and knowledge surrounding the various means to increase revenue in a business. These growth levers are precisely the same ones that a non-strategic but astute and capable PE-oriented buyer considers when creating their internal buy-side model, in the context of determining their expected IRR (internal rate of return), and therefore what they are able to afford as their maximum entry price (depending on their anticipated hold period).

The various growth levers typically fall into a few categories; as an example: geographic expansion, share-of-wallet-expansion (new products, features, or service tiers), price rationalization (assuming pricing is meaningfully below the competition, and has significant room to grow on an ROI-adjusted basis), supercharging sales capacity, or the increase of inbound leads through expanded marketing campaigns. Assuming a subscription SaaS business, churn reduction could also be seen as a growth driver. Discovering the applicability of each of these potential growth levers requires significant time spent with the executive team. Most have associated costs, and some require incurring costs ahead of revenue generation (R&D in the context of product development initiatives, or marketing campaign spend ahead of leads and closed sales). And each is relatively more or less defensible, depending on the risk associated with the initiative.

Once the most defensible of these levers have been identified and built into the model, together with associated costs, the aggregate implied growth rate should be checked. For example, it's wonderful to suggest that growth might jump from 20% to 70% with the implementation of a few smart initiatives, but it needs to hold up under the scrutiny of careful analysis. In the end, you're making a series of arguments for increased enterprise value, and each will be discounted to varying extents by the buyer. Again, non of these contemplate the direct and particular synergy value in either revenue or costs that the new owner expects to be able to realize. In some cases, it is possible to provide that analysis on their behalf, but those need to stand separately and alone from the core model.

Once the projections are finalized and the model is complete, it becomes the companion piece to the CIM in the post-NDA marketing of the business. It will be scrutinized and defended, and will become a centerpiece for discussion ahead of Indications of Interest, and later, formal Letters of Intent.

The process of model building is tantamount to a full analysis of any business, and nearly always reveals new stand along growth opportunities that management can realize, whether or not the business ultimately sells to a new owner.

M&A Expert Value Creation Points - Part 1, The Target List

Most sell-side focused M&A investment bankers, particularly those of us that lead with our sub-sector or sub-domain expertise, emphasize the strength of exiting relationships. The standing presumption is that if you've spoken with all of the strategic buyers' corporate development contacts on recent deals, and have a personal relationship with each, then picking up the phone is easy. And there's certainly some merit to the length and strength of a speed-dial list, but when we ask the question, "Which are the most logical buyers for your company, beyond those that have spoken with you in the last 6 months, or the ones that you think we already know?", that's when the conversation really gets interesting.

Once we've been hired, one of the first orders of business is the development of a target list. It might sound like a straightforward exercise: add up who you know, who we know, the obvious buyers, and the Private Equity funds that have existing platforms in the space, and put a pretty bow on it. But that assumes the obvious, easy, low hanging fruit is the totality of the buyer universe. At first blush, that may be true. What it ignores, however, is the opportunity to think more broadly about how certain other groups of buyers may perceive value in the company. To get there, you really have to put your thinking cap on. It's necessary to think beyond the obvious; in some cases re-factor the way the product value is stated, and in other cases, even the vertical or segment representing the company's present focus.

Let's make this a bit more concrete. Imagine we're taking a SaaS software provider to market, and that the very most obvious buyers are larger competitors with more comprehensive platform offerings, seeking the opportunity to acquire customers and upsell them to a more complete suite. In some cases, these particular buyers don't perceive maximal synergy, because for them, this solution does not represent a hole in their existing platform. Regardless, these remain the most obvious buyers, and they are typically your largest and best-known competitors. They sometimes possess different customer size focus -- imagine mid-market versus enterprise, for example -- or geographic focus, but in the end, at a technology and functionality level, the solution that they are buying duplicates something they've already developed, and presumably wish not to replace.

But what about a different group of buyers that doesn't already own this element of their solution, or may benefit from the customer base or in other ways, but for whom the base case rationale is less obvious? For these potential buyers, surfacing a rationale for acquisition requires a lot more thinking, knowledge of market dynamics, and often some inductive reasoning to infer the potential buyer's growth strategy. In some cases, it may even require packaging up the rationale, and injecting it into a dialogue with the VP of Corp dev, so that they can go away and rally internal support for the idea. What is really happening here equates to a fleshing out of our client's stand-alone corporate product / market strategy, because in each case, the alternative to selling to a buyer that can realize on any given thesis, is to take advantage of that same market opportunity directly -- either through new product development, or partnership, or both. Once the first potential buyer that might adopt this rationale for acquisition has been identified, all of their similarly motivated competitors can be added to that same sub-group on the target list. And so on this process is repeated, until the target list is significantly longer, and the number of possibly interested buyers is much greater.

Having recently hired a transaction advisor, most CEOs don't expect that the process of building out the target list to be so illuminating relative to their product / market strategy; but done right, it certainly does, and should provide for a significant expansion of the buyer universe which transcends the first-order list of obvious names.