Ongoing communication and strategy
The M&A process starts with a conversation with their lender. For businesses, strategy should be a vital part of the ongoing communication between the buyer and lender. That way, the lender can help evaluate opportunities as they arise. When the bank sees a buyer’s financials on a monthly or quarterly basis, the bank team is well positioned to assess whether a potential deal is worth exploring.
When the buyer is a private equity (PE) firm, the process can differ. PE firms usually maintain relationships with lending banks and reach out to their contacts when they’re interested in a deal. As those relationships mature, both parties benefit from a mutual understanding of the types of deal structures that work for the lending bank. Because PE firms tend to operate on shorter ROI timelines, deals may be structured differently to support their specific investment objectives. Lenders need to understand that the buyer makes decisions based on the goal of growing the company quickly; they will ask for more working capital and more term debt than an individual buyer typically would. That said, firms almost always have a solid understanding of what’s possible from a lending perspective.
Preparation and due diligence
Lenders should make sure the client is prepared for anything that might arise during or after the deal. Because there are so many factors to consider in any M&A deal, the financing structure isn’t always the same. Therefore, lenders should kick off the process by educating the client on what they should expect during the transaction based on their experience.
Preparing a client for a deal involves a few different exercises, all designed to mitigate risk and ensure the deal goes through as planned. First, lenders should make sure the buyer has assembled the right team to guide them through the process. The top three critical team members in any M&A deal are your banker, attorney and accountant. Clients should involve these necessary players early to maintain clear communication between parties.
Next, lenders should do due diligence. This includes challenging the buyer to test whether they have analyzed their strategy and considered benefits, costs, expectations and potential pitfalls. One of the most important functions a lender can perform for buyers is solidifying their understanding of why they’re purchasing a particular company and how their strategy will ultimately benefit their business. Growth alone may not be a good reason to acquire a company. It’s our job as both lender and advisor to evaluate whether the client’s reasoning is sound.
Double check the deal
Lenders should also help clients “stress test” the deal, starting with today’s environmental factors, and forecast what may happen under various conditions. For instance, what happens if sales drop 25 percent, or you lose your biggest customer to a competitor? How much would a 20 percent decline in gross profit margin shock debt service coverage? Lenders should confirm buyers have thought about these scenarios and can answer questions like these. If they can’t, it’s a red flag to the lender.
Lenders facilitate a deal by determining the best method of financing for the transaction. They add value by consulting on financing options and by doing it early, so they can address all potential issues before the contract has been signed.
Successful M&As start and end with trusted advisors. With the proper guidance from lenders and other professionals, buyers and sellers can execute and effective M&A process.
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