Much time has been spent analyzing M&A and consolidation trends impacting the medical device and manufacturing industries, and rightfully so. As transaction multiples remain strong and high-quality and well-heeled buyers continue to execute aggressive acquisition strategies, M&A announcements have seemingly become part of the everyday news cycle in our industry. Analyzing transaction metrics and speculating on what the next “big deal” will be is topnotch water cooler material—and for owners considering selling their businesses, a post-game focus and analysis is exceedingly helpful in setting valuation expectations and handicapping potential buyers. However, an area that doesn’t get much attention and is widely considered to be merely “procedural” is the transaction process—the set of activities required to complete these industry-shaping M&A deals. 

Once the decision has been made to sell, many business owners typically have a predetermined view on selling to a strategic buyer versus selling to a financial buyer. While this direction is helpful in shaping the universe of potential buyers, oftentimes owners don’t fully realize the processes involved in selling to a strategic buyer versus a financial buyer can be quite different. A more complete “game planning” discussion on what to expect during the transaction process with each set of buyers is most certainly warranted, but in this piece we will attempt to provide some insight on transaction structuring, due diligence, and transaction approval and closing.

Transaction Structuring
Although the headline in most M&A transaction negotiations is purchase price, much more must be considered when deciding on a transaction partner. Having a sense of what to expect from strategic and financial buyers on key terms such as form of consideration (cash vs. stock), contingent consideration (earn-outs), management compensation/non-competes, required equity roll-over, financing contingencies, and indemnification packages should help to avoid any surprises and set expectations. We’ve compiled some observations from recent transaction experiences:

Strategic Buyer Tendencies

• The ability to enjoy immediate synergies (both revenue and operational), as well as the strategic benefits (product line expansion, customer acquisition, geographic extension) allows strategic buyers to pay more than a financial buyer in many instances.
• With strategic buyers, business owners are most often selling 100 percent of their company. Depending on the buyer and transaction structure, the seller is often asked to take some stock in the combined entity as part of the overall transaction consideration. This allows for some post-transaction risk-sharing for the buyer, as well as for the seller to participate in some “upside” of the combined entity.
• Key managers are often retained on “like terms” as existing management teams, with opportunities for investment in the new or combined company limited when compared to opportunities with financial buyers. While exceptions can always be made, the salaries, titles, and benefits of key managers are often adjusted to align with the corporate policies of the buyer.
• With board-level sign-off required for most acquisitions, strategic buyers are often unable to meaningfully alter transactions’ structures to bridge negotiation gaps without first gaining formal approval from the board.

Financial Buyer Tendencies

• Competing with strategic buyers on valuation is challenging for financial buyers for various reasons, though primarily due to the inability to realize the immediate synergies that strategic buyers will enjoy as well as the need to use third-party financing to pay for the acquisition.
• Financial buyers are in the business of executing transactions, and can often be more flexible than a strategic buyer to meet a seller’s needs. Features such as earn-outs and equity co-investments are examples of levers financial buyers can pull to bridge valuation gaps and provide more upside to a seller.
• The speed at which most financial buyers gain approval and provide feedback is a key differentiator when compared to most strategic buyers. Sellers and their transaction advisors are often working directly with the decision-maker at a financial buyer, allowing for expedient feedback and decision-making.

Due Diligence
Once key transaction terms have been agreed upon between the buyer and seller, there is still much work to be done before closing the transaction. A letter-of-intent containing an exclusivity clause for the buyer as well as a detailed due diligence plan (among other items) is then negotiated and signed. This due diligence plan should include a detailed timeline and a roster of the diligence team (financial, environmental, insurance, regulatory, customer, legal, commercial, etc.). Executing transaction diligence typically requires the involvement of the seller’s executive management team as well the next level of managers to gather information and answer follow-up questions. The timeliness and organization of the due diligence process is crucial to maintaining the confidentiality of discussions and minimizing disruptions to the daily operations of the business, and can vary widely between strategic and financial buyers.

Strategic Buyer Diligence Execution

• Generally speaking, strategic buyers do not have a team dedicated to executing diligence; rather, they take a “diligence by committee” approach by leveraging internal resources. In the absence of a corporate (or business) development manager, the onus often falls on the chief financial officer to quarterback this process. This less-structured approach can often result in unexpected scheduling delays as business travel and other pre-scheduled meetings, conferences, and even paid time off can make scheduling on-site meetings more cumbersome.
• Although it is standard procedure, sellers often have concerns providing strategic buyers unfettered access to sensitive information such as pricing data, margins, intellectual property, and customer lists. Strategic buyers are privy to this data regardless of a deal’s outcome.
• Validating historical and projected financial performance is perhaps the most critical component of the due diligence process. However, strategic buyers spend nearly an equivalent amount of time examining and pressure testing cost accounting and operational metrics such as standards for setting overhead, material, and labor rates, and measuring and validating manufacturing throughput and efficiencies.
• For obvious reasons, most sellers prefer to keep the news that their business is up for sale confidential and limited to a few key managers and advisors. This is increasingly difficult as the president, CEO, or sales head from the buyer are on-site for facility tours and other diligence meetings. As opposed to financial buyers (whose visits can be explained as consultants, accountants, or lenders), the presence of top-level industry executives at a seller’s facility makes keeping a potential transaction under wraps more challenging.

Financial Buyer Diligence Execution

• At their core, financial buyers are dealmakers; as such, efficiently executing transactions is a key core competency and differentiator when compared to strategic buyers. The value of speed and certainty of closing with a well-established financial buyer should not be underestimated.
• As opposed to a strategic buyer, most financial buyers outsource the majority of their diligence work to third parties who specialize in transactional due diligence. Separate teams of financial, environmental, legal, insurance, and human resources experts will be engaged by the financial buyer to perform targeted diligence exercises. In most cases, the financial buyer and the seller’s advisor will conduct most of the information gathering and interfacing with diligence providers in an effort to limit daily disruptions to the seller and ensure a well-choreographed execution.
• During the diligence period, financial buyers tend to be more focused on the month-to-month financial performance of the company than strategic buyers. This is primarily due to the underwriting requirements of the lender(s) that will be used to finance the purchase, and their reliance on trailing-twelve-month financial metrics used to calculate the level of debt lenders are comfortable providing for the purchase. In addition, a separate set of meetings between the company and lenders is often required to secure financing.

Transaction Approval and Closing
Upon completion of due diligence and the negotiation and finalization of the requisite deal documents to formalize the transaction terms, the approval of various parties is required before documents are signed and funds transferred. This approval process varies widely from buyer to buyer, but can lead to unanticipated delays and transaction anxiety if the approval process is not clearly discussed and understood upfront.

Strategic Buyer Approval Process

• Strategic buyers often require formal board approval before an acquisition officially closes. The timing of this approval can be obtained at any point throughout the transaction process—understanding the nuances of this process is critical in avoiding unanticipated delays. With larger strategic buyers, this approval often can only be obtained during quarterly board meetings or at other pre-scheduled corporate assemblies.
• Deal financing is often provided by a strategic buyer’s existing lenders, eliminating the need for a separate credit approval process. While smaller strategic buyers may need to be mindful of tripping covenants or over-leveraging, many larger strategic buyers have credit facilities in place specifically designated for M&A activity.
• In most transactions, as a condition of closing, buyers will require calls with key customers to obtain their opinion of their relationship with the seller. Additionally, the buyer will look for assurances from the customer that the relationship will continue post-transaction and that key programs and supply agreements will remain unchanged. While the risk of a customer pulling work or meaningfully altering a relationship as a result of an acquisition is low, there have been rare instances where buyers need more time to think through the feedback received through customer calls.

Financial Buyer Approval Process

• As previously mentioned, one of the benefits of working with a financial buyer is the ability to quickly make decisions, including the final approval of a transaction post-due diligence. In many cases, the investment committee will have pre-approved the transaction, provided no material adverse findings arise during the diligence process.
• If meaningful issues arise with due diligence or unexpected material changes in the business (losing a customer or key program) transpire, financial buyers can usually find a path to a successful transaction. Aside from their belief in the business model and excitement about partnering with the company, one of the main motivators for financial buyers to complete a transaction is to avoid dead deal expenses. Unlike strategic buyers, who largely leverage internal resources to execute diligence, financial buyers spend hundreds of thousands of dollars with the third-party diligence providers previously discussed. That being said, walking away from a bad deal will clearly be more cost effective than eating dead deal expenses.  
• Underwriting approval delays from the lending partners of financial buyers is one of the few reasons for unexpected delays in transaction approval and closing post-due diligence from financial buyers. Despite separate lender meetings, due diligence requests, and timely communication of financial and business updates, lender approval can be delayed occasionally for reasons beyond the control of the buyer or seller.

The process involved in selling a business the right way is complex and involves many parties collaborating on countless work streams in order to reach a common goal. While the dynamics are different for every situation and buyer, this column hopefully provided a range of potential scenarios and questions that should be asked initially to avoid surprises. Ensuring that everyone’s eyes are wide open and on the same page before getting into the throes of a deal will undoubtedly make an arduous process a little less painful for all parties involved. 

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Brian Gorski is a vice president with PMCF and a member of the firm’s medical technology team. He has more than 12 years of transaction advisory experience, having advised public and private companies on merger and acquisition mandates, valuation matters, private placements and financing transactions. He can be reached at brian.gorski@pmcf.com.