Navigating the Complexities of Mergers & Acquisitions: A Step-by-Step M&A Guide for Small Business

Some business owners hope to hold on to their company for decades and perhaps even pass it on to their children or grandchildren. However, other entrepreneurs are looking for an exit plan.

In fact, according to the Business Enterprise Institute’s 2022 Business Owner Survey, 53% of business owners hope to sell or transfer ownership within the next ten years.

Mergers and acquisitions (M&A) can be an option for business owners to reach growth goals, diversify operations, or provide a strategic exit route. However, the M&A process is complex and requires careful planning and execution.

This guide provides a structured approach to navigating the merger and acquisition process, from due diligence to post-merger integration. We also highlight some common pitfalls to avoid.

1. Prepare for a Merger or Acquisition

Before embarking on an M&A transaction, it is crucial to clearly define your objectives. Are you looking for a buyer for your business so you have an exit plan? Do you want to acquire another company to access new technologies or expand into new markets? Or do you want to merge with a competitor to achieve economies of scale?

Aligning the transaction with your long-term goals is essential for success.

2. Assess Your Readiness

Evaluate your company’s readiness for a successful merger or acquisition by examining financial stability, operational capacity, and managerial bandwidth. This step is critical whether you plan to be a buyer or a seller.

For buyers, ensuring your business is stable enough to absorb another company without becoming overextended is crucial.

For sellers, it’s about getting the best price possible for the company. Work with your accountant to get a business valuation so you can set a realistic price target. They may also be able to recommend strategies to increase value, such as:

• Getting your bookkeeping and financial statements in order
• Taking steps to increase sales or strengthen cash flow
• Addressing customer concentration or supplier risks
• Improving processes to eliminate waste, inefficiencies, and redundancies

3. Find the Right Acquiring Company or Target Company

Now it’s time to identify the other entity in the merger or acquisition. If you already have a company in mind, you can reach out directly or through your attorney. Initiate contact to gauge their interest in a potential transaction.

If you don’t have another company in mind, you may want to enlist the help of a business broker or investment bank, depending on the size and complexities of the company. Business brokers and investment bankers work closely with buyers and sellers, helping identify potential companies and narrow options to the organizations that best match each party’s goals.

Once you identify the other party, both sides typically sign a letter of intent, which is a non-binding agreement that allows both parties to communicate their interest and confidential information without committing legally.

4. Perform Due Diligence

During the due diligence process, the acquiring company scrutinizes the target company’s financial information, legal standing, contractual obligations, business lifecycle, market position, and compliance with regulations. This financial analysis process helps uncover potential liabilities or issues that could impact the valuation or feasibility of the deal.

Of course, merging two distinct companies isn’t just about the financial aspects. It’s crucial to evaluate the other party’s operations, leadership styles, and company cultures. Cultural compatibility is often overlooked but critical for a smooth transition post-acquisition.

Pay close attention during this phase of the transaction. You shouldn’t have any major issues working through the initial discussions, letter of intent, and due diligence phases. If you experience difficult people, poor response times, or shoddy documentation, these can be red flags indicating the two companies aren’t a good fit at best or, at worst, one company has something to hide.

5. Valuation

Now it’s time to decide on a purchase price.

For mergers, it’s important to ascertain the value of both companies. This helps fairly allocate shares of the new legal entity to the owners of the former companies.

For example, if Company A is worth $1 million while Company B is worth $500,000, the new company should allocate its shares proportionally.

Acquisitions involve only one company valuation. There are several appropriate valuation methods to choose from, including:

• Book value. Subtract the company’s liabilities from its assets to determine owner’s equity. While simple, this method is rarely reliable for a going concern.
• Discounted cash flows. Estimate the value of the company based on the cash flows it’s expected to generate in the future. This method is more reliable than book value. However, the discount rate applied to the cash flows depends on assumptions made about future growth.
• Enterprise value. This method combines a company’s debt and equity and subtracts the amount of cash not used to fund business operations. It is desirable because it takes differing capital structures into account, and companies can look more or less successful depending on their capital structures.
• Multiples method. This method assumes similar companies sell for similar prices, so you need to identify other companies in the industry that have sold recently. Take that company’s sales price and divide it by its total sales or EBITDA (earnings before interest, taxes, depreciation, and amortization). You arrive at a number that is the multiple. Then, the multiple is applied to the target company’s sales or EBITDA to arrive at a valuation.

The ideal method depends on the situation and should reflect the target company’s specific circumstances and industry.

6. Deal Structuring

Decide on the structure of the proposed deal. There are three basic structures to choose from:

• Asset purchase. The buyer buys the assets of the target business.
• Stock purchase. An existing business purchases the stock of the acquired company.
• Two merging companies combine into one new entity.

Each has major differences in legal and tax implications, so it’s important to discuss this decision with your attorney and tax advisor.

 7. Negotiation and Agreement

Negotiation is a delicate phase where you finalize the terms of the transaction. This involves discussions on price, payment terms, contingencies, and warranties. Guidance from your attorney is crucial during this phase to ensure that your interests are adequately protected.

Once you agree on the terms, your attorney drafts the purchase agreement, which both parties sign. This legally binding document details all aspects of the deal, including the responsibilities of all parties, timelines, indemnities, and conditions for closing.

8. Closing and Post-Merger Integration

The closing process typically involves transferring payment and assets. Ensure all legal and regulatory requirements are met for a smooth closing.

Then it’s time for the integration phase. In a seamless integration, you’ll combine operations, align organizational structures, and integrate corporate cultures to realize the anticipated synergies of the M&A.

While there can be bumps in the road any time you try to merge employees and company cultures, transparent communication and change leadership strategies can minimize disruption and help you retain key talent through the transition.

9. Monitor and Adjust

After the merger, closely monitor the integration process and profit margins against expected outcomes and goals. You should be ready to make adjustments as needed to address any operational issues or cultural misalignments.

Structure, Negotiate, and Close M&A Transactions with Percipio Business Advisors

Mergers and acquisitions carry risks, even when both sides have good intentions and take the due diligence process seriously. However, a structured approach and the help of a trusted, experienced advisor can increase the likelihood of a successful transaction.

If you’re ready to discuss your options, contact Justin Niederklein, CPA at Percipio Business Advisors today. We’d love to help you carefully plan and execute your merger or acquisition to propel your business into new levels of growth and success.

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