Importance of Detail in the NBIO

You must take the time to address the many points of excruciating detail, so they are included in the NBIO. Some buyers resist this for a variety of reasons, some vendors don’t want to invest the time. But it is essential. And watch out for tricky ‘catch all’ terms that a buyer might put in such as ‘generally accepted practice’ or ‘normal or standard’ adjustments/conditions etc. One thing I’ve learned is that what a buyer regards as ‘generally accepted practice’ is not necessarily the same as what a vendor regards as fair or in the spirit of the negotiated deal.

Key Points to Include in the NBIO

So here are some things to look out for:

• Add a spreadsheet to the NBIO that defines what is included and excluded in the working capital and net debt adjustment. Base it on your recent balance sheet, get granular, do a line by line, for example get agreement on how they will determine all leave provisions.
• Separate out long service leave and general leave provisions, don’t fall into the trap of having them treated the same way.
• Don’t forget to push for net of tax adjustments in the net debt adjustment.
• Get clarity right up front on the restraint period that the buyer believes is ‘normal’.
• Get clarity on who will pay for the run-off PI insurance.
• If the buyer is going to insist on W&I insurance – who will pay?
• What is the buyer’s position on future dividends (if you are left with a minority position) or bonus arrangements. You can’t assume the status quo will be maintained.
• What will the new organisation structure look like, how will you and your team fit in? If you are expecting a board seat, this should be included in an NBIO.
• If you are planning on retiring soon, get that acknowledged in the NBIO.
• Whilst warranties and indemnities are developed during due diligence, you can get clarity within the NBIO on how those indemnities will be shared amongst the vendors. This is a big issue when there is an imbalance in the shareholding group.

The Eaton Square team are all experienced advisers. Most have run their own businesses. Our preference is to work with you from the start, not be called in after you have agreed to an NBIO. We work with our clients to ensure what they are agreeing to in an NBIO is what will be delivered.

Introduction

The demand for cloud-based technologies continues to surge. Even before global lockdowns forced the transformation of work practices, the migration to the cloud and the SaaSification of services, both public and private, have led to a further evolution in this digital age. According to Deloitte’s Q2 report, global spending on cloud services was up 11% from the previous quarter to US$34.6 billion.

“We’ve seen two years’ worth of digital transformation in two months.” – Satya Nadella, Microsoft CEO on a recent earnings call 

This transformation was the key driving force for M&A activity in the IT and software sector in 2020. There can be no doubt that demand for companies servicing the cloud sector will grow significantly in 2021 and beyond.

To guide your 2021 growth strategy, here are 8 lessons we learned from our SaaS and cloud computing clients:

• Lesson #1: You don’t have to be a unicorn to be beautiful
• Lesson #2: Be shockingly clear where you sit in the cloud
• Lesson #3: Technology is fleeting
• Lesson #4: Timing is everything – and nothing!
• Lesson #5: Smart partnering trumps hard work
• Lesson #6: It has to be easy!
• Lesson #7: It’s not about you – do your research
• Lesson #8: We all love a story

Lesson #1: You don’t have to be a unicorn to be beautiful

Neil Bourne

Salesforce, and many other SaaS/Cloud businesses, have upended the once accepted wisdom of how long and how much investment it takes to be globally successful. Readily available private capital enables the pursuit of ‘blitz-scaling’ strategies that prioritise growth and market share—ahead of profitability. This plays to the inherent strength of the SaaS/Cloud markets – the potential to scale and network quickly.

The magic trifecta

SaaS/Cloud businesses that demonstrate the magic trifecta of:

• Customer lifetime value economics
• Quality threshold revenue, and
• Sustained 50%+ CAGR growth

have been rewarded the ability to raise investment on massive multiples giving rise to unicorn (>$1BN) valuations.

What is the value potential?

Yes, we’d be delighted if all our investments turned into Unicorns. But experience tells us that most SaaS/Cloud businesses will, at some point, be constrained. The trick (or skill) is in understanding the value potential, regardless of constraint.

From an Eaton Square perspective, many of our clients in the SaaS/Cloud market have proven businesses in terms of revenues and profitability (or the ability to quickly become profitable). But for one reason or another they are hitting constraints on growth—and consequently, are no longer finding themselves inundated with investment offers. So instead, they are looking for alternative options to merely raising more capital. These might include finding a strategic partner to accelerate access to new markets or merging with a complementary business to achieve scale and relevance a different way.

We see the gaps

For the cross-border Eaton Square team, you don’t have to be a Unicorn to be beautiful. We are always interested in talking to businesses in the SaaS/Cloud technology sector about their plans and where they ‘fit’ in their fast-changing ecosystem. Our advantage is that we are continuously speaking to the buyers and sellers in the market, and we see the gaps. This is how we assist our clients realize their strategic goals by:

• Finding investors or buyers who bring more than just money – strategic partners able to value-add through complementary assets, capabilities and market reach to help realise full potential
• Helping more mature businesses restore their growth trajectory through targeted acquisitions.

Lesson #2: Be shockingly clear where you sit in the cloud

Warren Riddell

The cloud is a complex market. It is not static, and its change is not linear. Like a rain cloud, it billows at its edge and within. We are used to change, but here the market canvas warps as each thread is subject to individual change. Then there is the issue of abstraction. NIST developed the stack model of SaaS (applications), PaaS (platforms) and IaaS (infrastructure) to help visualise the cloud. But these layers can be unrelated. For example, SaaS can run on physical machines, and programs run on IaaS without a SaaS wrap. This complexity makes M&A tough to navigate.

We act for buyers and sellers in this market. We bring them together. But when a market canvas is ever-changing, matching demand with supply requires skill.

Cloud & SaaS M&A demand and supply

What is demand? Put simply, major global cloud players are seeking new technologies that will (a) give them a competitive edge in accessing those migrating to the cloud, (b) drive switching from a competitor, (c) drive down their own costs and (d) increase functionality and product offerings. They are seeking (a) sector-specific specialisations that embed industry nuances and processes, (b) technologies that facilitate the transmission of systems from owner to host quickly and error-free, (c) technologies that improve the efficiency and effectiveness of the host systems, and (d) to build on their existing brand permission to expand their product suite.

What is supply? We’ve seen it with the constant flow of transactions over the past few years – whether it’s at the big end like Slack/Salesforce (product suite expansion) or smaller acquisitions like Kasten/Veeam (technology advantage). There are multiple points of ‘fit’ within the expanding cloud ecosystem.

It’s more than product fit and value proposition

To be able to market a business sale to a major, you not only have to understand the ‘fit’ and value proposition in the cloud ecosystem, but you have to be able to articulate it to all key stakeholders (e.g., technologists, revenue officers, internal M&A teams etc). It’s hard enough doing this with established businesses, let alone emerging technologies that few truly comprehend.

The answer is having absolute clarity about where you sit in the cloud ecosystem and identifying the nodes of connectivity – both technological and commercial. If you can be clear about your position in the market, the majors can start to compute your value. But don’t assume that all majors will see the same fit or value proposition. So, do your research, understand how your technology or product will address their weaknesses and create opportunity – and be brave, tell them.

Lesson #3: Technology is fleeting

Patricia Glovsky

Companies work hard to gain market prominence.  Good ideas supported by revenue and market growth gain attention from large companies and competitors.  Technologies gaining market share become targets to be acquired by larger companies – that recognize a hole in their own product offering – and competing companies who want to take a share of growing markets.  Specifically, in a situation when smaller companies have developed timely technology solutions to address a new or growing issue/problem, copycat companies which can enter the market effectively and quickly begin to enter the market. For most, the technological advantage is subject to time.

The right time to sell

Companies with a lead market position may be approached to be acquired. They have a tough choice: continue as a standalone or sell out?

Acquirers most often come with resources to accelerate your growth. But if acquirers do not buy you, it’s likely the acquirer will build a competitive solution or buy a competitor and use the money and resources to accelerate the growth of a solution that is not you.  These competitive moves could impact and possibly block your growth.

Other large company acquirers may join the trend to buy your competitors.  If large acquirers start a buying trend and pick off your competitors, and you have not pursued a sale, you could discover that all of the larger companies have partnered up and your sale opportunities will be reduced.

Strike while the iron is hot

Like technology, opportunity can be fleeting. Once your company has achieved solid growth and revenue momentum, assess your exit options – are you on a path to go public?  Is the ideal growth to be achieved by partnering with a larger company?  If your story and growth path on the rise, consider an acquisition.  You want to assess your options while your story is strongest and not on the decline in order to maximize value.  You want to consider options before others try to enter your market and eat away at your growth potential and then your core. It’s one thing to be a smart technologist, it is another to be a smart entrepreneur.

Lesson #4: Timing is everything – and nothing!

Neil Bourne

It is the immutable force that can give or take away.  Choosing your timing for a corporate transaction always is a trade-off–a gamble. Go now or wait for a better valuation, and you might find yourself irrelevant, valueless.   The SaaS/Cloud market landscape continues to evolve with new segments emerging whilst others rapidly consolidate. Pick an advisor who understands this and can give you the tough love to make a call.

Hang around as a corporate advisor in the technology sector long enough and you meet many ‘could-have-been-king’ entrepreneurs whose company, at one point, was the player to beat in a hot sector. They had the chance to sell but choose to do it alone and a few years and, one or two missteps later, find that not only has the leadership mantle fallen to others but every major full-stack software vendor has either acquired some competitor or developed their own product.

Occasionally, we see companies that ace their timing either by good fortune or shrewd gamesmanship. Companies relatively early in their commercial development sell for the perceived value of their potential, unencumbered by any history.

Position your company as a scarce solution to an expanding market

The perfect storm for a ‘strategic sell’ occurs when a company can package itself as a scarce key to unlock a rapidly expanding market opportunity, particularly if that opportunity influences customer choices in adjacent market segments that are already core business for industry majors. Valuations rise when you are selling a gun in a knife fight.

Be sale-ready

Corporate transactions are rarely quick, simple or linear. And no matter how attractive you may be, capital is rationed and there is always competition for its deployment. So, make it easy for a buyer. Be prepared–and mitigate risks of timing.

In our experience, the best-prepared companies have ongoing conversations at board level asking these questions:

• Who is responsible for maintaining an ‘outside-in’ view of the market that we operate in?
• How do we anticipate our market evolving over the next few years? Can this be boiled down to a few scenarios to explore the implications for our company and shareholders?
• Who do we think could buy the company and what value would we unlock for different buyers?
• How can we help potential buyers understand and validate the value that we bring?
• How else could potential acquirers plug the gap in their business if they don’t buy us?
• Do we have the internal processes in place to support due diligence from multiple investors or buyers – without distracting management from running the business?
• Do we have a relationship with a corporate advisor who understands our space and is available to help us consider or explore options?

Lesson #5: Smart partnering trumps hard work

Neil Bourne

One of the things you learn early in your career of selling technology to customers is that selling from an unknown brand is really tough. If you work hard enough, you can pick up some visionary, early-adopter customers but it remains an uphill struggle. Too many customers play it safe.

If you put yourself in the shoes of the buyer then come to realise that  ‘Corporate Survival 101’ teaches people that the upside of choosing the ‘best’ solution from an unknown supplier is massively outweighed by the downside protection of buying from a safe brand. Back in the mainframe era, this became weaponised as ‘Nobody ever got fired for buying IBM’.

If your product is technically superior or ground-breaking, this may also be a problem insofar that buyers will either not believe that your product can reliably deliver the claimed benefits or will require extensive testing before even considering a pilot deployment.

Partnership and validation

So, what is an emerging Independent Software Vendor (ISV) to do? It’s about partnering and validation.

Invest the time and effort to learn how to work the various partnership ecosystems that major vendors have built around themselves.

ISVs that demonstrate skilful collaboration with credible partners can create value faster than going it alone. Create credibility by association and validate what you have created. Let others help prove your value.

Lesson #6: It has to be easy!

Warren Riddell

Bandwidth, it’s all about bandwidth. Everyone is time poor and as digital bandwidth grows, human bandwidth seems to shrink. Even the elevator pitch has become prehistoric, as life changing decisions are made with the left or right flick of a finger.

What does this mean for M&A in the tech world?

Smart simplicity

Invest to make it easy for others to understand your value proposition. Think ‘point of view,’ what language, what words, resonate with your target audience. Are you targeting another techie or someone from sales or the head of strategy? One size does not fit all. Your pitch must be designed with the target in mind. So, you need more than one pitch, as you will be exposed to many points of view on an M&A journey.

Understand the difference between features and benefits. Techies love features, but are they relevant to the needs of the target? Is there a benefit, can you articulate it simply? Can they get it in one?

Smart-simplicity, as an MO, shows empathy for your audience in this time poor age. Empathy is a demonstration of respect for the needs of your audience. Combine this with a highly engaging and relevant pitch, and you will establish a rapport where your audience will be prepared to invest their time in engaging to understand your value proposition to them.

You do the work to make it easy for them. Make it smart, make it simple.

Lesson #7: It’s not about you – do your research

Warren Riddell

Avoid being the hero of your own story. Your passion for your technology can be infectious and create momentum in the market and with your people. If you don’t believe in it, why should others? Smart tech entrepreneurs understand this, but they also understand there is another point of view. The truly smart tech entrepreneurs invest in understanding their target market and customers.

Know thy customers

We have worked with tech entrepreneurs all around the world. Most have inspirational technical expertise that created innovative products and services. But only a few have shown a depth of understanding of the broader market and what drives their customers. These tech entrepreneurs can pragmatically blend their solution with the needs of their clients. They are informed, so rather than push their technology, they position themselves alongside their clients to pull their solution into place.

But to achieve this requires investment–in time and money. When it seems like every cent must be used to develop tangible and measurable technology. The intangibility and immeasurability of KYC or KYM are relatively tougher to justify. But without it, the technology may be stillborn.

Another error many emerging tech companies make is delegating market intelligence to junior ranks – so leadership can focus on the technology. This is wrong. Leadership must demonstrate fluency in their understanding of their ecosphere and market, their customer needs, trends and drivers.

Nothing beats direct research, think top-down, not bottom-up. Be knowledgeable, remain inquisitive, and listen.

Lesson #8: We all love a story

Warren Riddell

What is more effective? Fact telling or storytelling? Of course, it depends on the circumstances. But when we are marketing our products and services, we never truly know the extent of a client’s needs. So, we ask questions to identify needs that we seek to address. But there is another way – stimulate the client’s imagination so they apply your solution to their problem. Tell a story, allow the client to make the connection.

Storytelling to forge connections

The process of selling a product or service requires connectivity. We are seeking a connection with a customer or client. The connection is their belief that we can resolve their need.

So how best to seed connections? Yes, we can tell them the facts (we do this/we do that) but how often do you see a client’s eye glaze over with facts. Then they ask a question about something you’d already answered. Unless the client does the work, the connection will not be comprehended. But the client must want to do the work – they need to be engaged.

We use case studies as a way of telling a story. But most case studies are technical – the need, the solution etc. They are usually no more than structured facts. However, case studies can form the basis of telling a more engaging story that will trigger connections with your client. The ‘tricks’ that I have found effective in writing engaging case studies or scenarios include:

• Your story must have something unanticipated in it – enough to generate an ‘ah-ha’ moment
• Something needs to happen that is unexpected – that has the potential, or reality, of conflict
• The context of time and place must be real and vivid so the client can imagine it
• Ensure the story you weave (even in case studies) is worth the journey for your client – they are investing in it
• Include and illustrate behaviours or characters – let’s face it, there is a behavioural aspect in all we do
• Lastly, it is often the backstory of a case study that is more interesting and engaging than the project itself. Draw from this and avoid templates.

One story that I always ask my clients is about their personal journey and how their business was established. This can be the most enlightening story of all to create deep connections with a client and their needs. But some words of warning – make it concise and fun for your audience. Use it to show your empathy for them and your wit. Don’t make it all about you.

Finding a strategic partner that ‘gets it’

If you’re not entirely sure where your company stands in this niche, we are happy to schedule a call with you to discuss. Our global team is comprised of senior M&A professionals across the US, Europe and Asia-Pacific. Each of us has extensive experience in Software and IT Services with special focus on cloud computing and SaaS. Learn more about our Cloud sector team here.

The discussions centred on:

• The COVID journey to date and how business confidence has swung about
• How the market (clients and peers) has responded to date
• Impact on culture (values, leadership, behaviours) – how may this affect the future
• How operations were impacted and the effectiveness of responses
• Impact on planning, strategy, growth aspirations and ownership succession

As a general observation, the Australian engineering sector performed strongly in the first six months of the pandemic. This may be due to a combination of strong contract backlogs and improved utilisation due to lockdown. The firms we spoke with reported strong performance in the key areas of infrastructure, housing, mining, with many reporting above budget performance.

Before dipping into some of the insights and nuances that we can share, what became very clear was the dynamic and fluid nature of the crisis – and how it is not limited to the epidemic. Our first meeting was in late July and the last was in late September. Even over a two-month period, we saw issues and priorities shift from the first meetings to the last; with border controls, the crisis in Victoria, and geopolitical issues related to the USA and relations with PRC becoming more prominent.

Some key points of feedback we’d like to share include:

Markets

• The benefit of a balanced portfolio of private and public sector clients.  If you don’t have public sector clients now, good luck in trying to enter that market – join the queue.
• Another balanced portfolio point – local clients vs non-local (i.e. interstate or international). Many engineering firms have been in denial about the true cost of servicing distant clients.

Culture, relationships and staff

• One consequence of staff working in physical isolation is disconnection. This poses a risk of fracturing the cultural bonds and ties that form the company. Predatory competitors and head-hunters understand this – it’s an opportunity for them to poach your best people.
• Many firms are introducing real and virtual ways to preserve internal relationships and connectivity. Working remotely requires intentional effort to hold their team together.
• Generally, utilisation has risen, which has been reflected in increased profitability. But there is an awareness that persistent remote working will have a negative impact on long-term client relationships. And relationships are the enduring glue between a service provider and its client. Alternative strategies are needed.
• Remote working may be fine for the introverted and experienced professional. But not for the trainee or new graduate. This led onto a further point…
• How to value people in a virtual working environment?

Operations

• Initially, many firms considered the permanent downsizing of office space to reflect staff preferences and reduce cost. But over the last few months, many have changed their mind. Staff attitudes to isolation have changed and the negative impact on culture is becoming clearer to leadership. Some firms are considering increasing their office footprint to give staff more individual space and when allowed, more collective space for group work.
• Generally, tech support for remote working has been efficient and effective.

Strategy and succession

• COVID-19 and the fallout from it is seen as yet another risk that leaders and managers will need to address for the foreseeable future. Having had to face increasing globalised competitive forces and the commoditisation of formerly high-value services; the current crisis is a further disruption that must be addressed. Can it be turned into an opportunity?
• Planning and budgeting will require firms to remain flexible and nimble.
• It is probable that more cash will have to be retained in the business, to provide a cushion, as opposed to being distributed to shareholders.
• Succession and exit plans will need to be reviewed.
• Specialist firms are still fielding approaches from acquisitive groups – but generally, their focus is on preserving their business performance rather than being distracted in these uncertain times.

To close, we found many common themes across each of the industry segments. Despite the heady uncertainty in March and April, most leaders and their teams adapted to the lockdown and changed working arrangements quickly and effectively. Clients were understanding and a mutually supportive environment developed.

The first six months of 2020 has been commercially strong for many in the industry – coming off a strong backlog or order book at the end of 2019. However, the concern expressed in our meetings is for 2021 – the impact of derailed immigration, higher general unemployment and the lag effect of the new economic stimulus. The consensus was that the crisis would weed out underperforming firms unless they restructure. The most obvious way is through local mergers of similar businesses to create scale and reduce cost.

What impressed us all from the ten meetings with these leaders was the quality of their thinking and their responsiveness to this crisis.

Based on the great success of these sessions in Asia-Pacific, we are now inviting mid-market engineering firms in the US, Canada and Europe to also join us for a one-hour discussion where we can share some of the insights we have found. If you’re interested, you can join an upcoming session here.

Roger Collins-Woolcock
Principal

Roger is a Principal of Eaton Square and focusses on mergers and acquisitions particularly in the professional services of engineering, survey, planning, landscape architecture and quantity surveying. Majority of his 30-year career with ASX listed firm Cardno where he was the General Manager of the 2000 person Australia and New Zealand region.

Email: roger.collins-woolcock@eatonsq.com | Mobile: +61 412 778 807

Mark Goodwin
Managing Principal

Mark is a Principal of Eaton Square based in Perth and is focused on M&A and debt and equity raising. He brings over 15 years extensive M&A experience having led a large number of successful transactions in Australia, Asia, UK and the US.

Email: mark.goodwin@eatonsq.com | Mobile: +61 422 005 439

Here are 6 key takeaways from our chat with global Consulting Engineering firms:

1. M&A in strategic areas of focus remains unchanged. But naturally, each potential buyer will have a different focus and set of priorities. Areas of interest include rail and road infrastructure, minerals and metals mining, energy and energy distribution, urban design and planning, water and wastewater systems.
2. Better understood geographic markets, in terms of managing business risk, are a priority. Such as North America, Western Europe and Australia/New Zealand.
3. Size of the team matters. This is an interesting issue. Scale has always been a critical issue in an acquisition, it is a proxy for corporate sustainability and resilience – relative to the specific expertise and availability of that expertise. As a general measure, a headcount of less than 50 may be deemed as sub-scale. But also headcounts of over 500, depending on circumstances, may have too much impact on an existing business. So, both situations may impact the buyer’s existing management structure at a time their focus is on maintaining business as usual. The sweet spot appears to be in the 100-500 range.
4. Due diligence will be tougher, but there is no reason valuations will be impacted. Validating and interrogating forecasts and assumptions will be more rigorous. Questions from investment committees will be directed at understanding the depth of evidence based research to justifying proposals. Vendors will need to explicitly address the impact of COVID-19 on their market and their business.
5. Whilst travel restrictions are in place, the transaction process will be hindered and slowed down. This will act as a filter for buyers in determining where they should focus, from a deal completion point of view.
6. Recognition that the process will be longer, but it should not stop. Use the time to wisely to understand the companies that may wish to sell in 2021 or 2022. This will make preparing investment proposals for internal approval more robust.

The final message we received was a unequivocal, “please continue to bring us deals”. Because the larger international firms aim to come out of the COVID-19 crisis stronger than when they went in.

Lastly, an insight we gleaned from the conversations was that there could be a bubble of transactions in one to two years’ time, as a backlog builds. An oversupply may put downward pressure on valuation multiples and increased volume may further delay timing.

Given these factors, if you had planned to sell in 2020-21, and your business performance has remained relatively strong – talk to us. The opportunity for a successful transaction now may remain. But you will need to be prepared, particularly in justifying forecasts.

You may book a call with any of our Engineering team here.

Roger Collins-Woolcock
Principal

Roger is a Principal of Eaton Square and focusses on mergers and acquisitions particularly in the professional services of engineering, survey, planning, landscape architecture and quantity surveying. Majority of his 30-year career with ASX listed firm Cardno where he was the General Manager of the 2000 person Australia and New Zealand region.

Email: roger.collins-woolcock@eatonsq.com | Mobile: +61 412 778 807

Mark Goodwin
Managing Principal

Mark is a Principal of Eaton Square based in Perth and is focused on M&A and debt and equity raising. He brings over 15 years extensive M&A experience having led a large number of successful transactions in Australia, Asia, UK and the US.

Email: mark.goodwin@eatonsq.com | Mobile: +61 422 005 439

During the current crisis, we have maintained constant dialogue with acquirers of businesses, covering major international and national groups, investment funds, private equity and family offices. We also talk to banks and other providers of working capital. Our reach includes Australia, New Zealand, North America and Europe.

Market Impact on Valuations and Process

In summary, the market has changed. But it is important to understand how and the impact this is having on valuations and process.

Our view is that strategic acquisition activity is holding its relevance and value to acquirers. Whereas financial acquisitions are either on hold or being re-valued. If you are unsure about the difference, here is a summary:

• Strategic – put simply, the fit is more important than the profit. Long-term value to the acquirer is derived from how the acquired business fits within their existing operations. E.g., adds more capability, markets, depth, clients, leadership, management, diversification, quality, expertise, intellectual property, competitive positioning, etc. Given that competitive intensity in leading sectors is relentless, an asset that gives an edge remains valuable. It is important to note that strategic acquirers can also include private equity funds, where their existing investments are complemented through further acquisitions.
• Financial – it is about profit, cash flow and IRR. Long-term value is considered in terms of a future exit to generate a capital gain to the acquirer.

Sectors with M&A Activity

So, what are we seeing?

Major international and national engineering and IT services consulting and advisory firms are still seeking strategic acquisitions. Core areas of focus have not changed, such as infrastructure, resources, urban planning and adjacencies. Yes, there are changes in focus due to the Covid-19 crisis, as areas such as hospitality and leisure cool, and supply chain and related technology heat up.

We are also seeing companies looking to source additional debt to bolster their balance sheets and make ‘attractive’ acquisitions while they can.

Finally, we are also seeing some activity from financial investors to supplement existing investments. But generally financial investors appear to be waiting. More to preserve their cash reserves than use it for predatory acquisitions (fire sale purchases).

Stricter Due Diligence Expected

So, what has changed?

Acquirers will be tougher on due diligence. Whilst we don’t see valuations necessarily falling, we do see due diligence becoming more diligent as acquirers dig deeper to understand the value drivers of a business, its sustainability and resilience. We don’t see this changing for, at least, a couple of years.

For owners who had set 2020/2021 as their target date to implement succession or sale, our advice is don’t change your plans. Just be better prepared and remain confident.

If you would like to discuss your plans and get greater clarity, please contact any of the Eaton Square Principals. You may book a call here.

Reece Adnams
Global Managing Principal

Reece Adnams is the CEO and Global Managing Principal of Eaton Square, a Mergers and Acquisitions and Capital Services advisor for technology, services and other growth companies founded in 2008.

But how to make sense of it?

From discussions with our client network we see the strategies falling into two groups with the following attributes:

• Offensive M&A plays to capitalise on changing demand drivers:
  • Moving into new markets
  • Skilling up to deepen an existing market presence
  • Strengthening an existing competitive position
  • Merging to strengthen the capital and cost base of the partners
• Defensive M&A plays to focus on core strength:
  • Spinning out non-core services
  • Spinning out higher risk/higher return activities to re-balance sustainable margin
  • Restructuring the balance sheet through selective asset sales
  • Partnering, where permissible, to restructure the supply/value chain

How could these drivers manifest themselves in business sectors globally?

Our network of clients, capital providers, and other advisors point to the following sectors:

Opportunities for offensive M&A:

• Infrastructure engineering – as governments stimulate the sector to counter the economic downturn
• Mining and mining services – similar to the above but as ‘fuel’ to economic growth
• Building services – interior design and construction, to address changing workplace practices
• Health – to address the increased demand for tele-health and related services
• Food/produce – building economic resilience in the complete supply chain
• Technology/remote working – both in terms of hard and soft applications, e.g. hard technology to make efficient working practices, but also softer/HR practices affecting culture and accessing previously unavailable talent
• Consulting – change management and organisational re-design specialists with strong social and community awareness (EQ/SQ capabilities)
• Commercial real estate – serviced/co-working offices being relocated to respond to a shift away from CBD concentrations. Possibly working in tandem with large organisations instigating hub and spoke real estate strategies
• On-Shoring – inverting of many previous trends to now acquire geographically (or jurisdictional) relevant local service providers to reduce business risk
• Retail – a greater push into e-commerce – and acquiring capabilities to enact successfully. So not just tech platforms but distribution warehouses, robotics, delivery-collaborations, etc.

Opportunities for defensive M&A:

• Aviation – consolidation and merger of the sector to strengthen balance sheets and manage operating costs
• Hospitality – refocus on competitive positioning and meeting changed demand characteristics, regaining direct customer relationships, restructuring and refinancing through mergers, disposals and acquisitions, potential for new collaboration models between real estate owners and brand owners
• Commercial real estate – dispersed companies (e.g. banks) with hub-and-spoke facilities (i.e. large downtown offices and many regional branches) restructuring and decentralising their office network to enable and empower branches within their customer communities.
• Retail – disposals and ‘re-purposing’ of current spaces (e.g. Canada’s largest mall in Toronto – just 25% of tenants paid their rent in April!). Finally, a big push to e-commerce and acquiring the capabilities to enact successfully. So not just tech platform, but distribution warehouses, robotics, delivery-collaborations, etc.
• Diversified conglomerates – re-balancing portfolios to increase consistency and decrease variance of returns, by either selling to PE, trade sales, de-mergers etc.

There can be no doubt that the economic uncertainty caused by the COVID-19 crisis is making business leaders more cautious. There is a trade-off between holding investment capital in the short-medium term and remaining sustainably competitive and profitable in the medium to long term. Like many M&A opportunities, whether you are a buyer or seller, it comes down to timing. Researching, developing options and planning now will be time well spent.

If you would like to discuss your plans for your business, we are offering a one-hour complimentary call with any of our experts. You may book a call here.

Andrew Light
Managing Principal, North America

Andrew brings over 25 years of expertise having both professional firm and client-side industry experience. Andrew was formerly Vice President of consulting & deals for PricewaterhouseCoopers (PwC), as well as having held senior client-side roles with enterprises such as IBM, British Telecom, Shell, and Sapient.

Here are our team’s 5 top observations and thoughts on some potential near-term actions that business owners might want to consider during the self-isolation lull:

5 Key Implications  to Consider for Business Owners

1. Procrastination over strategy execution. Timeframes for current conversations will stretch as buyers and sellers wait to see business trending back to normal trading conditions.
2. Self-isolation accelerating digital businesses adoption. Ranging from video conferencing becoming the default for meetings to an increased share of spend for online retail. The acceleration of transition to cloud-based services will drive increased demand for Managed Service Providers, Managed Security Service Providers, Data Centres and greater high-speed internet connectivity. Concurrent with this will be a spike in demand for IT Services skills both to migrate legacy systems and to play competitive catch-up with new ‘born-digital’ upstarts.
3. Tough times for impacted strategic buyers. Those strategic acquirers directly impacted will be focussed on preserving their cash. This may lead to some acquirers walking away or pushing for discounts.
4. Financial buyers are still cashed up. Pitchbook, a private capital markets data service, reports that as of the end of 2019 there is nearly US$800Bn in Venture Capital and Private Equity ‘dry powder’, i.e. funds not invested. Whilst in 2000, and to some extent, in 2007-2009 we saw fund managers returning funds to investors due to the poor supply of investment-grade opportunities. Our view now is that most fund managers will stick things out on the basis that: i) this is an overdue correction to inflated valuations; ii) there is still a steady supply of baby boomer businesses owners wanting to exit; iii) COVID-19 will disrupt the market in 2020, but for quality businesses the impacts will wash out. The more adroit fund managers will see COVID-19 as an opportunity—not a problem. So sellers should remain prepared.
5. Outlook for unprepared sellers isn’t great. COVID-19 is a stark reminder of how quickly buying windows can snap shut and illustrates the apocryphal saying in our world that ‘time kills all deals’. Too often we see deals fall apart due to sellers who struggle to get their information together quickly and so lose credibility. Or sellers who justify a valuation on sentiment, not fact or justifiable rationale. Competition obviously helps in valuation discussions, however, many unprepared sellers struggle to widen the buyer set beyond the ‘usual suspects’. Being prepared means you are proactively testing all corners of the market and getting clarity on how the market values your business. This does take time.

3 Potential Actions for Business Owners

1. Transaction readiness review — find out what is involved in getting yourself ready to respond quickly in a sales process.
2. Growth strategy and narrative — prepare materials to help educate buyers/investors from outside your industry about your competitive landscape, growth trends and likely future developments. Feed this into your own growth strategy and narrative around what you expect your business to look like in the future — and how it will get there.
3. Valuation metrics and comparable transactions — find out how external investors or buyers will value your business; get to understand the valuation ranges and the factors that can help you achieve an exit in the upper end.

Whilst you are in self-isolation, take time to consider the opportunity this is giving you to reflect. We would be pleased to help you in this process – remotely! Feel free to contact me or one of my Eaton Square colleagues for a confidential discussion.

Neil Bourne
Managing Principal

E: neil.bourne@eatonsq.com

P: +61  416199696

Seeing it from both sides is invaluable. The chain of command within a buyer’s organisation is more unforgiving than ever. Jobs and careers are at stake. Reputations can be won or lost. Relationships can be fractured. And that goes for the outsourced experts too, such as the accounting, tax and legal advisers. These people have a significant impact on the constructive energy within a deal. They can drain it or support it. Too often they drain it.

Five insights I’ve learned from sale mandates in 2020:

1) Flawed judgement around materiality

If I am to take one fundamental learning from working either alongside or opposite a buyer’s external expert adviser, it is their repeated failure to understand materiality within the deal process. Too often I have experienced flawed judgement around materiality that hinders the process and can lead to deal failure because a seller has just had enough.

This is where an experienced transaction advisor must step in – be they on the buy or sell side. All parties must agree on materiality upfront. But this is not just related to quantum, it also relates to timing. Buyers should focus on the big picture stuff first. It signals you are thinking strategically and will value your acquisition. Don’t start by challenging the policy to bring pets into the office, as I once witnessed.

My advice to sellers is to have this discussion upfront. Agree rules of engagement and insist they are applied to the buyer’s expert advisors.

2) Be prepared for repetition

Inevitably there will be overlaps in scope between the accounting, tax, legal and commercial due diligence teams. You will be asked the same question more than once. And despite the most sophisticated digital data room set up, you must be prepared to breathe through the frustration you will feel.

It is rare for the different due diligence teams to share the detail. They will share contentious issues that make it to a roundtable discussion. But when they are working separately and remotely accessing the data room, they will fire off a question to the seller rather than checking it internally. There are two reasons for this. One—they are professionally liable for any negligence on their part, so they need the primary research; Two—they are usually working to a tight timetable.

So, sellers must just be prepared for the frustration of dealing with multiple questions from multiple inquisitors that often are the same. Just ensure your answers are consistent!

3) Understand that price and payment may change

So, you have agreed a ‘deal’ in principle. You are already working out the distribution of proceeds to the shareholders and considering the after-tax capital gain.

Then comes a couple of surprises. The buyer is insisting on a cash-free debt-free deal and that sufficient working capital is left in the business. That’s okay you think – we have no debt and I want to take the cash anyway, that’s great. And we always have enough working capital so what’s the problem?

The problem is around definition. For example, the buyer is not talking just about bank debt, but also ‘debt-like’ items like long service leave or staff bonuses. And a buyer’s calculation of what working capital is required may come as a shock. Adjusting an agreed sale price for these items can have a material impact on the final price paid. So, don’t wait until the final negotiations to learn how the buyer calculates these adjustments. Ask for their model upfront at the time the EOI is being discussed.

Then there is the timing of payments. Ignoring structural payments such as earn outs or deferred fixed payments, there is the issue of an escrow amount. The buyer will want to keep back a percentage of the payment due on financial close to cover any unforeseen adjustments. This can be anywhere from 5% to 15% and held back, in full or in part, from anywhere from six to eighteen months. Sellers should not be bullied by the external lawyers into agreeing on an unreasonable escrow. It should relate to the materiality of the deal and also the risk profile of the business.

4) Know when you have got a good deal

We have negotiated a good price and terms of payment and have signed an EOI which grants the buyer exclusivity for 90 days. The marketing process had gone well, and we had choices, there was more than one serious buyer. Our results are continuing to strengthen, it is probable we will exceed this year’s budget, the one we included in the IM.

But now due diligence is starting to get us down. We feel the questioning is puerile and the buyer isn’t thinking strategically or addressing our concerns regarding integration and how we tell our staff and customers. A couple of thorny issues have surfaced, which may mean we need to give indemnities.

This is when some of the shareholders may say, let’s trade on and sell for an even bigger valuation in one to two years. This situation is not unusual and can be very tempting. It requires a very steady hand from the leadership of the seller. Upfront when advising sell-side clients, I always get them to discuss valuation, what they are seeking and why they are seeking it. But often if an offer comes in that exceeds their expectation, it can trigger dysfunctional behaviour in the greedy. You need to be ready for this.

If, as a seller, the offer has met your expectations don’t let the process to get to financial close make you change your expectations of value. The two, the offer and the process, are not related. There are far too many stories of deals being broken for this reason and fortunes lost.

5) Timing is everything in balancing risk and return

I have made this comment many times. But in the last year or so it has been proved true in spades.

If it is your intent to sell and your business has demonstrated a consistent track record of profitability and steady growth, and it has sustainable scale, do you need to wait? Ordinarily no.

But some may say let’s bank another year’s revenue and profit growth and get even more for the business. In this case it is not your intent to sell, it is to grow and take the risk of that growth. Unfortunately, too many business owners who have had years of steady growth forget the element of risk and think that growth will be automatically banked. You cannot assume that growth in revenue and/or profitability is ordained.

If you are ready to sell and the market is ready to buy – why take the risk of delay, particularly if your expectations can be met.

The usual response to this is that we want more. So, ask yourself – how much is enough? From my experience it is the truly smart business owners who know when to bank what they have built.

Growth strategies for specialist and boutique firms can be fraught with contradictions and conflicts. The potential for growth and scale is a fundamental component of a firm’s exit valuation, but how to grow at the right pace whilst retaining a compelling and attractive value proposition to potential acquirers?

In seeking growth, too many firms enter new product markets prematurely and destroy the core component of their value to an acquirer. Others seeking to expand geographically spread themselves too thin and start to burn equity. So, what is the answer?

Here are seven lessons from advisory and transaction mandates we have undertaken for our specialist and boutique clients:

1.  Resist the temptation to become a generalist.

   This might sound obvious, but specialist firms often try and take their existing clients on a ‘generalist’ journey. “We can do that as well”, you may hear yourself say when buoyed by the success of a relationship and apparent proximity of additional revenue. For a boutique firm, ‘generalism’ is the slippery slope to oblivion, why compete with other generalists, it will detract from your attractiveness to an acquirer and undermine your raison d’être.

2.  Deep dive into market segments.

   Look to apply your expertise into sub-segments of your target markets. This will give you a granular understanding of the application of your expertise, deeper insights into your client’s issues, how your client’s industry segments operate and where they are placed in those market segments. The upshot is a strengthening of both your expertise and your understanding of your client’s business – both attributes enhance the value of your firm. But this requires investment in time and money.

3. Develop a strategy to achieve ‘unprompted awareness’ of your expertise in your chosen markets.
   

   Many of us speak at or attend conferences, and many clients can be ‘conference-overdosed’, but for those who don’t understand deeper buying processes what you are striving for is the nirvana of ‘unprompted, or top of mind, awareness’. For a boutique firm that is aiming to be heard above the noise from the ‘usual suspects’, this comes from continuous, consistent and prolonged exposure at the right events, committees, think tanks, joint seminars, press coverage etc. Achieve open recognition for being an expert who has solved an issue – demonstrate insight from experience. As I heard at a planning workshop last week “Be seen, be heard, be read”.

4. Allocate team responsibility and share the love.

   Too many boutique firms operate the way young kids play soccer – they chase the ball like a swarm. Even a small firm can allocate internal responsibility for multiple market segments and allow experts to be developed across a spread of niche markets. Sometimes team members fear they will be allocated a market that will have no future or be downright boring. If that’s the case, then they are not a team but a group of competing individuals. Teams work together, and support and trust each other. If sub-segments are not yielding the right return from the right effort, move on. Boutique firms should be considered teams, as opposed to larger firms that may have that ‘up or out’ competitive culture.

5. Invest time and money in operational succession.
   

   Can the level of revenue and profit remain at current levels and ideally grow if you, the owner, sell-out or step back? Too often founders of firms struggle to transition their leadership and relationships to those coming through because they have not invested time and money into operational succession. For example, they have not recruited well enough, or their ego remains a barrier (a symptom of this is that they can’t retain good people), or both. If you can’t prove you have achieved operational succession you can’t expect a top multiple and valuation for your business.

6. Plan strategically not tactically.

   Too many boutique or specialist firms confuse being nimble with being strategic. Yes, be tactically nimble so you can compete more effectively against the ‘usual suspects’ but operate within a strategic plan – build and share your own strategy-on-a-page that is focused on the who, what and why.

7. Build resilience into your culture and leadership.
   

   The highs are exhilarating but the lows can be debilitating. Ensure your team can cope with both, that the highs don’t create false courage (aka believing your own bullshit) and the lows jettison the faint-hearted. Develop an empowered culture that is trusting, nurturing and supportive, through effective communication, transparency and a likeminded set of values and behaviours. More than ever acquirers are performing due diligence on a target’s culture, experienced acquirers seek a cultural fit, without it an investment can be worthless.

Lastly, thanks to Thor Essman for this insightful comment added to my earlier post:

“Be humble. Hubris kills more companies than cash flow”.

Doesn’t it just!

Any questions? Feel free to contact me by email at warren.riddell@eatonsq.com. In the past year, Eaton Square has advised on more than one transaction a month and we see the market getting more intense as succession issues bite (supply-side) and larger firms seek to strengthen their offerings and competitive positioning (demand side) by acquiring businesses that have a clear understanding of both their identity and their market.

Here are 12 M&A lessons from FY19.

Too many owners are unable to sell down to staff because their staff can’t afford it. So, a trade sale to a third party is the only practical exit. Here are twelve questions to help you reflect on your options and actions:

1. Why do you want to sell?

   The answer is critical; you have to be honest with yourself and the buyer. Do you just want to cash in? There is nothing wrong with that, but if you do, have you made yourself indispensable? Have you achieved operational succession?

2. What is your price expectation?
   

   Have you tested this honestly against the market? Don’t just ask your accountant or lawyer buddies. Do you have informed and objective research? Do you understand why deals are priced the way they are, including the way terms of payment can be structured?

3. Are you prepared to stay in the business for a minimum period?

   If not, think again or expect a lower price. During that time are you prepared to work for someone else who may not be as smart as you? If you get an exceptional price you probably won’t care.

4. What will you do when you leave the business?

   Have a clear view, even if you keep it to yourself. Many leave after the minimum period, but others grasp the new opportunity and stay. Be clear about what sort of buyer you want, for both your future choices and those of your people.

5. Is your next tier of management credible to a buyer?

   The buyer will want to see inter-generational leadership in place; they won’t want to supply their own leadership for your business. Have you invested sufficiently in this aspect of your succession?

6. Where is the firm in its business cycle?

   How far out can you see? Could trading start to cool in a couple of years? If so, don’t wait. Too many owners leave it too late to exit. Sell on the up, not at the top. If you can see the top you are on the way down.

7. Will you have to normalise the accounts to prove your value?

   If so, expect a negotiation you probably won’t win. Your accounts need to be as clean as possible, are they?

8. Be clear about what you want from an acquirer, it shouldn’t be just about the money.

   Consider fit, culture, trustworthiness, reputation and quality. Think about the players in the market that have these qualities. One more thing, don’t chase a potential buyer until you are convinced they have the money and are prepared to spend it.

9. Have you been approached already?

   Don’t waste time with tyre kickers. Unless the acquirer can demonstrate they know the process and have done it before it could cost you dearly, in time and value. Don’t expect overseas buyers to readily cross continents to meet you, these transactions can’t easily be done remotely; in the first instance look closer to home for a buyer.

10. Do you realise the sale process could take at least six months and could occupy a great deal of your time?

    What will be the impact on the firm if you take your foot off the gas? Don’t try and do this yourself, for every dollar reduction in profit read a multiplied reduction in the sale price for which you are looking.

11. What about private equity?

    It can work if structured well, but also it may increase the pressure and stress. Private equity invests to exit after around three years and seek to at least double their money in that time. It is the start of a new journey for an owner, not the end of one.

12. Do you have a compelling and infectious vision?

    Whether it is a strategic acquirer or a financial investor, they need to be excited by the potential of your business. Can you demonstrate that you understand your market, be it clients and competition, where it is heading, your competitive advantage and how your business will grow over the next three years?

Any questions? Feel free to contact me by email at warren.riddell@eatonsq.com. In the past year, Eaton Square has advised on more than one transaction a month and we see the market getting more intense as succession issues bite (supply side) and larger firms seek to strengthen their offerings and competitive positioning (demand side).