Guest Article: I Just Called to Say I Love You
Stephen McGee, National Practice Leader at Grant Thornton Corporate Finance, discusses unsolicited acquisition approaches in middle-market M&A.
Stevie Wonder was on to something when he wrote, “I just called to say I love you”; I’m just not sure he realized he was describing middle-market M&A. The volume of unsolicited acquisition approaches being made to privately held companies in the United States is staggering. Some business owners are receiving two or three phone calls a week from potential suitors.
But who are these people making the approaches? Broadly, they can be grouped into three buckets:
These guys are dialing for dollars — in some cases, trying to shake loose a sell-side mandate and in other cases working on behalf of a private equity group that’s trying to generate a proprietary deal. It’s all about volume with these guys, and the hit rate is extremely low, reflecting the usually poor quality of the approach. It’s the M&A market’s equivalent of spamming.
Private equity boiler rooms
Not unlike the business brokers, the boiler room refers to the armies of MBA grads hired by some of the larger private equity funds who are also dialing for dollars. It’s arguably a more professional approach because it’s usually targeted to a specific sector, and at least there is a checkbook behind it. But they are often working with target lists that, for the most part, don’t match their real investment criteria. While there might be some initial excitement, it can fade rapidly if they find out you are smaller than the kind of company they typically like to invest in.
Now it’s starting to feel more real. Strategic buyers will often undertake proactive buy-side searches that are targeted at adding a specific capability. They may do this using their own people, or they may engage an advisor to help them with their approaches. For the most part, there is a good reason they are calling you in particular, and there is certainly a checkbook at the other end of the line. The problem is that these legitimate approaches often get lost in the noise created by the business brokers and the boiler rooms. These various approaches may go some way toward explaining why — every year — a significant number of disclosed M&A transactions are “unadvised.” What on earth is going on here?
The answer is pretty simple: Buyers love proprietary deals and hate auction processes. They believe it is far better to shake out a proprietary deal through a direct approach than to receive a call from an investment banker like me. We know of one acquisition search firm that proudly advertises (to the private equity community) how its proprietary deals trade at 5.5x EBITDA as compared with advised deals trading at 8.5x and auctions at 9x. Think about it for a moment — this firm is openly saying that there is a 3.5x EBITDA difference between engaging a firm to run an auction process and responding to an unsolicited approach.
This means that unadvised sellers are most likely leaving cash on the table. So what is a business owner supposed to do with all of this? Thankfully, a good many business owners know exactly what to do, and that is to drop these approaches in the circular file, but you do run a slight risk of throwing the baby out with the bathwater and missing a legitimate opportunity. Being in the business, we tend to know what is viable and what is not, and if we are not sure, we can pick up the phone to call the potential suitor and ask a few simple questions. In doing so, we can quickly ferret out how realistic the approach is.
There is definitely some logic to all of this. The value of your company should be greater than the sum of its parts. We like to think about M&A transactions creating value not simply transferring value. This can be best illustrated through our pricing formula, P = V + (S + C)e — where P is price, V is value (meaning the somewhat scientific calculation of business value), S is story, C is competition, and e is the power of emotion. In responding to an unsolicited approach, you lack the opportunity to develop the S or the story. Instead, you more than likely hand over three years’ worth of financial statements, and that is no way to tell the story of what your company has to offer. Similarly, by talking only with the buyer that has approached you, you eliminate the C and the opportunity to use competitive tension to drive up the price. There may be plenty of emotion, but its effect will be limited without other elements of the equation. It’s the story, the competition and the emotion that go a long way to explaining the difference between a proprietary deal trading at 5.5x EBITDA and an auction process trading at 9x EBITDA.
Interestingly, all of this approach noise not only creates issues for sellers, but also presents an equally challenging environment for buyers — real buyers, that is. This chaotic environment makes it critically important for a real buyer to differentiate its approach from all of the other approaches landing on the business owner’s desk. And that is easier said than done. The single biggest challenge in executing any proactive acquisition search is making your approach stand out from everyone else’s so that it does not end up in the target’s circular file.
It would seem that both buyers and sellers will have to contend with a lot of noise in the market for years to come, because the volume of cold calling seems to be increasing, not decreasing. As buyers search for that elusive proprietary deal, sellers should consider the positive effect that an advisor and a well-run sale process can have on a valuation. So the next time someone calls to say they love you, look to Stevie Wonder for inspiration and tell them “ ‘I ain’t gonna stand for it.’ ”
About Grant Thornton Corporate Finance
Grant Thornton Corporate Finance LLC is a broker-dealer registered with FINRA and SIPC and a wholly owned subsidiary of Grant Thornton LLP.
This article is not intended to answer specific questions or suggest suitability of action in a particular case. For additional information on the issues discussed, contact Stephen McGee, National Practice Leader Grant Thornton Corporate Finance LLC, at 617.848.4988.