Latest / What is Business Development? / Episode 102: BD-BOK Chapter 16 Understanding Mergers & Acquisitions

Transcript

Episode 102: BD-BOK Chapter 16 Understanding Mergers & Acquisitions · What is Business Development?

• 0:00
  Speaker 1: The question we are tackling today is pretty fundamental to
• 0:04
  Speaker 1: corporate strategy. How does a company, let's say it generates
• 0:08
  Speaker 1: fifty million in revenue, owns maybe ten million in physical assets,
• 0:13
  Speaker 1: and then suddenly it sells for two hundred million dollars.
• 0:16
  Speaker 2: It's that valuation, multiplier and action. And if you're a
• 0:20
  Speaker 2: business developer, you really really need to understand the mechanics here.
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  Speaker 2: Why is that Because you're not just selling a product,
• 0:27
  Speaker 2: you are day in and day out structurally building the
• 0:30
  Speaker 2: very value that allows that multiplier to even exist.
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  Speaker 1: And that is the absolute mission of this deep dive.
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  Speaker 1: It's customized for you, our listener. We're going to dissect
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  Speaker 1: the core mechanisms of mergers and acquisitions M and A,
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  Speaker 1: and we're using the insights laid out in the Business
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  Speaker 1: Development Body of Knowledge.
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  Speaker 2: It all starts with a deceptively simple equation in that
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  Speaker 2: material price equals intrinsic value plus extrinsic value.
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  Speaker 1: Okay, so let's break that down. Intrinsic value that seems straightforward.
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  Speaker 2: It is. It's the tangible net assets, you know, the
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  Speaker 2: physical stuff, the equipment, the inventory, the cash sitting in
• 1:02
  Speaker 2: the bank.
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  Speaker 1: And as the material points out, any deals that are
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  Speaker 1: based purely on that intrinsic value, well, those are typically
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  Speaker 1: distressed companies, liquidation sales.
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  Speaker 2: Exactly, the real money, the thing that creates that massive
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  Speaker 2: sale price is the extrinsic value. It's the price you
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  Speaker 2: pay above the net asset.
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  Speaker 1: And that intangible amount is what the business development body
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  Speaker 1: of knowledge calls goodwill.
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  Speaker 2: Yes, And this is where we really anchor the entire
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  Speaker 2: deep dive, because the material gives us a central thesis,
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  Speaker 2: a really core idea, which is that goodwill is fundamentally
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  Speaker 2: equal to brand trust. It's the buyer's belief, their assurance
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  Speaker 2: that the revenue stream and the customer base are going
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  Speaker 2: to survive the transition.
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  Speaker 1: Okay, so if brand trust is what drives goodwill, and
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  Speaker 1: goodwill is what drives that huge acquisition price, who's in
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  Speaker 1: the engine room, who is building that trust every single day?
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  Speaker 2: Well, that is the unequivocal role of the business development team.
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  Speaker 2: The official definition of BD right from the material is
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  Speaker 2: customer and community advocacy that creates corporate growth.
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  Speaker 1: I love this next part. We capture that idea. The
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  Speaker 1: material gives us a great internal nickname for the strategy.
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  Speaker 3: It's a good one.
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  Speaker 1: Winning through friendship or WTF for short.
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  Speaker 3: It's memorable, isn't it?
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  Speaker 2: And it reminds you that every single act of advocacy,
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  Speaker 2: every effort you make to secure customer loyalty, that directly
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  Speaker 2: translates into a higher negotiation ceiling when the company goes
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  Speaker 2: up for sale.
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  Speaker 1: So that principle is the thread connecting everything we're about
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  Speaker 1: to talk about.
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  Speaker 2: That's right, Maximizing that M and A valuation multiple, it
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  Speaker 2: really means structurally optimizing the performance and just as importantly,
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  Speaker 2: the data integrity of your BD team.
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  Speaker 1: All right, So let's see how this BD build value
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  Speaker 1: fits into the M and A process. We can start
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  Speaker 1: with corporate growth strategies. Companies can grow in two main ways. First,
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  Speaker 1: you have organic growth. This is the slow and steady
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  Speaker 1: way you acquire individual customers, you sell your products one
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  Speaker 1: by one.
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  Speaker 2: And then there's the alternative inorganic growth. This is the
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  Speaker 2: high speed strategy. Instead of winning one customer, you acquire
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  Speaker 2: the entire customer base of another corporation through an M
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  Speaker 2: and A deal.
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  Speaker 1: So when a company wants to grab market share fast
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  Speaker 1: in organic growth, it's the turbo booster. Now M and
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  Speaker 1: A itself. It breaks down into two core mechanics. You
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  Speaker 1: have a merger where two or more companies fuse into one,
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  Speaker 1: shares are exchanged or charts get blended, and.
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  Speaker 2: Then you have an acquisition, which is a bit simpler.
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  Speaker 2: One corporation just buys all, or at least a controlling
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  Speaker 2: interest of the other one, and that company me being
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  Speaker 2: bought is called the target.
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  Speaker 1: And the person managing all this is the corporate developer,
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  Speaker 1: the CD.
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  Speaker 3: Right.
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  Speaker 2: They manage the whole life cycle from finding that target
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  Speaker 2: all the way through to making sure there's a successful
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  Speaker 2: post sale integration, you know, to really maximize the return
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  Speaker 2: on that investment.
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  Speaker 1: We hear a lot about the drama of acquisitions. There
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  Speaker 1: are friendly takeovers, that's when the target's board of directors
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  Speaker 1: is completely on board with the deal.
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  Speaker 2: But then you have the other kind, the high stakes
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  Speaker 2: headline hostile takeovers. And in a hostile scenario, the goal
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  Speaker 2: is still the same, you want to get a controlling
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  Speaker 2: interest of the stock, but the methods are shall we say,
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  Speaker 2: a lot more aggressive. Well, the acquirer might make a
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  Speaker 2: tender offer that's basically an invitation to all the shareholders
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  Speaker 2: to sell their stock directly to them, usually at a
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  Speaker 2: price above the market rate.
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  Speaker 1: So they bypass the board.
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  Speaker 2: Exactly, or they might engage in a proxy fight. They
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  Speaker 2: buy up some shares and then they lobby other shareholders
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  Speaker 2: to give them their votes. The goal is to get
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  Speaker 2: enough votes to replace the existing board with their own people.
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  Speaker 1: These successful M and A events, they're often called liquidity
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  Speaker 1: events right because the original owners and investors can finally
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  Speaker 1: cash out their shares.
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  Speaker 2: That's the one and while going public is one path
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  Speaker 2: to liquidity, the material also highlights other exit strategies, things
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  Speaker 2: like an employee stock ownership plan and ESOP where the
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  Speaker 2: shareholders actually sell their interest to the company's own employees.
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  Speaker 1: Long before any of those headline events, the CD is
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  Speaker 1: out there working and their first big job is deal sourcing.
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  Speaker 2: Right finding targets that are a good strategic fit for
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  Speaker 2: the parent company's growth plan. This takes a ton of
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  Speaker 2: market research, prospecting, and very discreetly engaging potential targets to
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  Speaker 2: see if they'd even consider a sale, and.
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  Speaker 1: CDs don't do this alone. They lean heavily on investment.
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  Speaker 2: Bankers, the specialized brokers. They get massive commissions for bringing
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  Speaker 2: deals to the table, and they're critical for helping structure
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  Speaker 2: the financing and just keeping the communication flowing.
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  Speaker 1: Which brings us to the analytical core of the whole process.
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  Speaker 1: Deal analysis. This is where the price gets set.
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  Speaker 2: And for established corporations, you know, the ones with positive earnings,
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  Speaker 2: the valuation method of choice, according to the Body of Knowledge,
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  Speaker 2: is the earnings multiplier, specifically the IVEBITDA multiple.
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  Speaker 1: Okay, this is the formula you really need to get
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  Speaker 1: your head around. Valuation equals the earnings multiplier times EBITDA
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  Speaker 1: and just.
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  Speaker 2: As a quick refresher, is earnings before interest, taxes, depreciation
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  Speaker 2: and amortization. It's it's basically a clean measure of the
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  Speaker 2: company's operational.
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  Speaker 1: Cash flow, and they often average it over the past
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  Speaker 1: three years or so, right to smooth things out exactly.
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  Speaker 2: But crucially, that multiple, it is not standard. It's intensely negotiated.
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  Speaker 2: And this is the moment where all the bad team's
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  Speaker 2: work becomes quantifiable, becomes a number.
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  Speaker 1: How does that work?
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  Speaker 3: Well?
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  Speaker 2: Research cited in the material from Sherman Heart gives us
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  Speaker 2: a really clear roadmap. It details the exact qualitative factors
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  Speaker 2: that influence that negotiated multiple.
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  Speaker 1: And this list is fascinating because it proves the price
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  Speaker 1: isn't just about raw earnings It's about the quality and
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  Speaker 1: the resilience of the relationships your bad team has built.
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  Speaker 2: One hundred percent. The factors that push that multiplier higher
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  Speaker 2: things like the company's size relative to its market share
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  Speaker 2: or niche, or having strong barriers to entry.
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  Speaker 1: Meaning it's hard for competitors to just copy what you do.
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  Speaker 2: Right. The quality of past performance is another one, but
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  Speaker 2: the most direct measure tied to be it's the quality
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  Speaker 2: of the.
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  Speaker 3: Customer health scores.
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  Speaker 1: So this is the hard data, the validation of that
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  Speaker 1: brand trust we talked about. It shows how stable and
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  Speaker 1: how satisfied your customer base really is.
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  Speaker 2: And a company with high turn with poor health scores,
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  Speaker 2: that tells a buyer the acquired revenue won't last and
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  Speaker 2: that just creters the multiplayer.
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  Speaker 1: So what are some other factors.
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  Speaker 2: Well, they all circle back to trust, instability, the quality
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  Speaker 2: of the management team, how predictable the cash flow is,
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  Speaker 2: customer revenue diversification, even the quality of unique products. They're
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  Speaker 2: all components of that big picture goodwill.
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  Speaker 1: We can actually see this multiplier effect really clearly when
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  Speaker 1: we compare different sectors.
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  Speaker 3: Yeah, the data on this is striking.
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  Speaker 1: An analysis by NYU professor Aswath Damadarin on recent acquisitions.
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  Speaker 1: It just illustrates this valuation gap perfectly.
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  Speaker 3: It does.
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  Speaker 2: Take the average multiple first a and aerospace and defense corporation,
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  Speaker 2: it's sitting at around thirteen point thirty eight. Now contrast
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  Speaker 2: that with the average multiple for a company and the
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  Speaker 2: autopart sector. It's only seven point eighty six.
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  Speaker 1: Wow, that's a huge difference, almost double it is.
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  Speaker 2: And that difference is driven by the perception of stability,
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  Speaker 2: those barriers to entry and the longevity of customer contracts.
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  Speaker 2: Think about a long term defense contract versus highly signical
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  Speaker 2: consumer auto parts. The multiple is the market's final judgment
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  Speaker 2: on the quality of a company's relationships.
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  Speaker 1: Now, to round this out, the body of knowledge does
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  Speaker 1: cover three other evaluation methods.
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  Speaker 3: Right for different situations.
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  Speaker 2: For a startup that isn't profitable yet, you might use
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  Speaker 2: a revenue multiplier.
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  Speaker 1: And if the target is a public company, the simplest
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  Speaker 1: measure is its market capitalization, just the share price times
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  Speaker 1: the number of shares, and the.
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  Speaker 2: Final method liquidation value. That's only for distressed assets, you know,
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  Speaker 2: companies facing bankruptcy. This one explicitly excludes all the intangible
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  Speaker 2: stuff like goodwill. It's just about the tangible equipment and inventory.
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  Speaker 2: It's the absolute lowest valuation you can get.
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  Speaker 1: So once that preliminary valuation range is set, the CD
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  Speaker 1: team moves into the d tailed planning and management phase.
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  Speaker 1: They form a full acquisition team.
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  Speaker 3: And this team has to be cross functional.
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  Speaker 2: It includes internal leaders from prospect, customer, product and community
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  Speaker 2: development mean all those angles covered, and they're joined by
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  Speaker 2: third parties like lawyers and lenders.
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  Speaker 1: The first big administrative step here is the letter of
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  Speaker 1: Intent the LOI.
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  Speaker 2: And this lists the proposed terms like the price range
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  Speaker 2: and financing. They're usually non binding at this stage, but
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  Speaker 2: the real teeth of the LOI are in its protective clauses.
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  Speaker 1: What do you mean?
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  Speaker 2: Well, the LOI is really about securing access and commitment.
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  Speaker 2: It mandates confidentiality and it guarantees the buyer data access
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  Speaker 2: for the next big phase okay, and critically, it usually
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  Speaker 2: includes a no shop or standstill clause. This prevents the
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  Speaker 2: seller from shopping the deal around to other buyers for
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  Speaker 2: a set period of time.
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  Speaker 1: And if the deal falls apart there might be a
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  Speaker 1: breakup fee.
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  Speaker 2: There might be, and to show they're serious, the buyer
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  Speaker 2: also puts down a good faith deposit. Sometimes called earnest
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  Speaker 2: money and.
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  Speaker 1: Executing that LOI that triggers the most intense phase of
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  Speaker 1: all due diligence.
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  Speaker 3: The forensic examination.
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  Speaker 2: This is where they go through every single record, financial, legal, operational.
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  Speaker 2: It's the moment of truth where all the BD teams
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  Speaker 2: claims about stability are either validated or they're debunked.
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  Speaker 1: And for the BD folks listening, you need to pay
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  Speaker 1: very close attention to this phase.
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  Speaker 3: Absolutely.
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  Speaker 2: The prospect development teams lead scores and sales forecasts, they're
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  Speaker 2: going to be rigorously tested for realism. The customer development
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  Speaker 2: team's metrics get put under a microscope, account growth, retention,
• 10:32
  Speaker 2: and those all important customer health scores.
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  Speaker 1: But the business development body of knowledge stresses a huge,
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  Speaker 1: almost existential risk during due diligence that's specifically about customer
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  Speaker 1: contracts and it's the issue of novation.
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  Speaker 2: This is a total deal breaker for the acquired revenue.
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  Speaker 2: Novation is the legal process of transferring a contract to
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  Speaker 2: the new owner simply by substituting the buyer's name for
• 10:57
  Speaker 2: the seller's name.
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  Speaker 1: And if the original contract doesn't allow.
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  Speaker 2: For that, then the buyer can't legally step into the
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  Speaker 2: seller's shoes and service that contract. If novation is blocked
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  Speaker 2: by the contract's terms or by regulations, the whole thing
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  Speaker 2: can fall apart.
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  Speaker 1: What's the worst case scenario here?
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  Speaker 2: It's alarming. If novation fails, the customer might have the
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  Speaker 2: contractual right to just terminate the agreement completely gone, or
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  Speaker 2: at the very least force the buyer to recompete for
• 11:21
  Speaker 2: that revenue.
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  Speaker 1: So that lost revenue directly erodes the goodwill that the
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  Speaker 1: BD team was supposed to have built.
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  Speaker 2: It creates a massive post sale headache. So mitigating that
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  Speaker 2: novation risk is a huge part of structuring the final deal,
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  Speaker 2: which also involves, of course, the financing.
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  Speaker 1: Right, and the options there range from simple cash offers,
• 11:39
  Speaker 1: either all cash from the buyer or something called a
• 11:42
  Speaker 1: leveraged buyout an LBO, which uses debt financing from.
• 11:45
  Speaker 2: Lenders, or the seller might agree to finance the deal themselves.
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  Speaker 2: They accept debt through a promisory note and get paid
• 11:52
  Speaker 2: out over time.
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  Speaker 1: You also see contingent payments things called.
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  Speaker 2: Burnouts right where extra payments are tied to the acquired
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  Speaker 2: company hit specific financial goals after the acquisition.
• 12:02
  Speaker 1: And finally, the buyer can use its own stock or
• 12:05
  Speaker 1: convertible securities as part of.
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  Speaker 2: The payment and all of these financial and legal terms,
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  Speaker 2: the final price, the payment structure, indemnifications, it's all codified
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  Speaker 2: in the final legal step, the acquisition agreement.
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  Speaker 1: That final agreement also outlines what's required for the last
• 12:21
  Speaker 1: critical phase post sale integration.
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  Speaker 2: The CD team's job is never done. They are continually
• 12:27
  Speaker 2: monitoring key metrics to make sure that the projected ROI
• 12:30
  Speaker 2: is actually being met.
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  Speaker 3: That BD built.
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  Speaker 2: Brand trust has to survive the transition to the new company,
• 12:36
  Speaker 2: and that.
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  Speaker 1: Really brings us full circle. We've mapped the whole m
• 12:38
  Speaker 1: and a process from the philosophical definition of value all
• 12:43
  Speaker 1: the way to the nuts and bolts of closing.
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  Speaker 2: The deal, all through the lens of the business development
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  Speaker 2: body of knowledge.
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  Speaker 1: So let's consolidate this. What are the three most essential
• 12:52
  Speaker 1: takeaways for you, the business developer listening right now?
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  Speaker 3: Time to synthesize the critical actions. Let's do it.
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  Speaker 1: Takeaway Number one, WTF is value? And you have to
• 13:03
  Speaker 1: remember the price of a healthy, thriving company is driven
• 13:06
  Speaker 1: by goodwill. That intangible value and the material is crystal clear.
• 13:12
  Speaker 1: Goodwill is brand trust.
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  Speaker 2: And that trust is cultivated through your diligent customer and
• 13:17
  Speaker 2: community advocacy. Every single effort of winning through friendship is
• 13:21
  Speaker 2: building the foundation for the highest possible sale price.
• 13:24
  Speaker 1: Takeaway number two the multiplier battleground valuation is a factor
• 13:29
  Speaker 1: of that earning's multiplayer but the multiple isn't determined by
• 13:32
  Speaker 1: some market average. It's determined by qualitative negotiation.
• 13:36
  Speaker 2: And you, the BD team, you directly control the critical
• 13:39
  Speaker 2: factors that Shermanheart cites, especially the quality of your customer
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  Speaker 2: health scores and the stability of the management and customer experience.
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  Speaker 2: High scores equal a higher multiple period. That explains that
• 13:50
  Speaker 2: dramatic spread and valuations we saw on the Damodaren stats.
• 13:54
  Speaker 1: And finally, take away number three the integration imperative. The
• 13:58
  Speaker 1: deal is not closed until the revenue is a during
• 14:01
  Speaker 1: due diligence. The BD and Customer development teams have to
• 14:04
  Speaker 1: be laser focused on making sure every single major contract
• 14:07
  Speaker 1: can be successfully novated.
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  Speaker 2: Because failure to achieve novation introduces just massive risk, the
• 14:13
  Speaker 2: potential for customer termination, which directly undermines the value you
• 14:17
  Speaker 2: just acquired and torpedoes the CD team's post sale ROI.
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  Speaker 1: You now I have the full map of how corporate valuation.
• 14:24
  Speaker 2: Works and if the ultimate goal of business development is
• 14:26
  Speaker 2: to maximize growth through that customer and community advocacy. Then
• 14:30
  Speaker 2: every single b D activity, I mean, from mitigating a
• 14:33
  Speaker 2: health score risk to securing favorable contract language, it's all
• 14:37
  Speaker 2: essentially a leverage point, a lever on that final M
• 14:39
  Speaker 2: and a valuation multiple.
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  Speaker 1: So the question for you is how high can you
• 14:43
  Speaker 1: push that multiplier today? Thank you for diving deep with
• 14:46
  Speaker 1: us