Experienced CFOs know that merger and acquisition (M&A) deals can be complicated and demanding, from finding a strategic fit to conducting due diligence to post acquisition integration. And M&A is even more challenging when one private company acquires another private company, especially if it is a cross-border acquisition.

Mergers and Acquisitions: A CFO’s Role

Timing is everything with acquisitions and CFOs are often the point person making the economic business case to justify investing company capital in a potential target company. The pressure is on.

An independent perspective by a CFO is also critical to accurately answer key acquisition questions including:

  • How solid are the company’s financials (revenue and profitability forecasts) and performance metrics?
  • Are assumptions regarding growth, market share, and competitive advantage relative to the competitive landscape realistic?
  • Is there revenue visibility and predictability?
  • What is the go-to market strategy and product/service roadmap for the combined company?
  • Is the cap table and ownership structure clean?
  • What unrecorded liabilities or exposure is there?
  • Are there tax compliance issues and could the potential transaction be structured in a tax-advantage way?
  • Are there potential synergies, cost savings and/or economies of scale resulting from the acquisition?
  • Is there a cultural fit between the organizations?

These are important considerations for CFOs and are common to most M&A deals.

“Private to Private” Acquisitions: Valuation Dilemmas

In addition to the typical challenges of M&A transactions, what happens when both companies are privately held?  In these situations, things get even more interesting.

Valuing one or both private companies is a big challenge.  Because both companies are not publicly traded on a stock exchange, both entities must be valued, not just the target company.  Valuation methodologies include discounted cash flows, industry comparables, growth metrics and market share. Often a combination of all or several of these factors are used to establish a valuation.

Valuation of two private companies is particularly difficult when the transaction includes a partial or all stock consideration or transaction as part of the acquisition. The acquiring company must have a solid basis for determining its own value in the market before it can then apply a like set of assumptions to the target company for valuation purposes. The two companies must then agree on their “relative” value to establish an exchange ratio of the acquiring company’s stock for the target company’s stock.  This is often a contentious point of discussion during M&A negotiations.

As an example, I was the CFO of a private company that was in the process of acquiring another private company.   About half of the consideration for the acquisition of the target company was to be paid in stock.   The first challenge was how to value our equity as the acquirer.  We applied a number of traditional valuation metrics, such as discounted cash flows, revenue multiples and industry comparables.  Ultimately, we had our valuation analysis validated by several investment bankers.

The next step was to establish a realistic enterprise value for the company we had targeted for acquisition.  We applied several valuation methodologies to estimate the value of the target company. Fortunately, there had also been some recent private company financings and acquisitions that could be utilized as data points.

Not surprisingly (as often occurs in M&A situations), the team at the target company continued to disagree with our valuation estimates for both the value of our company as well as how their company was valued.  They felt that the valuation estimate for our company was too high and the value we placed on their company was too low. We needed to resolve this conflict, and this resulted in a difficult set of intense discussions and negotiations. The Board of Directors of both companies had to engage in the negotiation of this specific point on relative valuation. Ultimately, we bridged the gap in valuation expectations of both parties by hiring a third-party valuation expert as part of the due diligence process.

“Private for Private” Acquisitions: Financing Alternatives

Financing strategies for a private company attempting to acquire another private company can also get complicated.

This involves considerations around the financing structure and vehicles to be used to finance the acquisition.  Private company acquirers typically do not have the same access to capital as public companies.   Should the acquiring company pay all cash, all stock, a combination of cash and stock or debt?

The larger the private-to-private acquisition, the less likely a private company acquirer will use all cash as consideration for the acquisition.   If a private company acquirer decides to turn to an external financing source through the issuance of new equity in order to finance an acquisition, this adds complexity around the valuation of the acquiring company’s stock and could cause significant delays in the execution of the acquisition.  This is because the acquiring company will both have to raise capital from investors at a new valuation and terms, and these same investors will have to support the use of these proceeds for the acquisition, which adds additional complexity to the fundraising process.

If the acquirer looks to fund the acquisition of a private company through debt, then the acquiring company may have to put together a syndicate of lender(s). This can add additional time and effort and additional debt service liabilities for the acquiring company.

Foreign-Owned Acquisitions: Unique Challenges

If the acquisition candidate is not only private but is also foreign-owned, even more complexities come into play. Due diligence must include a review of the legal/regulatory compliance issues involved in executing the acquisition as well as any tax issues.

For example, a client of mine was in the process of acquiring a private German company. The German regulators required that the stock purchase agreement be read aloud, word-by-word, in both German and English as a compliance procedure.  This took hours to complete and cost more than $50,000. Private companies can also have different compliance issues than public companies in a specific country.  Therefore, when acquiring a foreign company, it is critical to engage the right team of advisors of bankers, lawyers, tax experts, and accountants, in country, to ensure all applicable local regulatory and tax issues are understood.

It is also important to pay attention to the logistics when closing a foreign-domicile acquisition. Don’t expect the banks to work on your timetable. They won’t. You may need to consider local country banking holidays and bank processing times, or you could delay the timing of the close of your acquisition.

Finally, don’t discount the complexities of assimilating a foreign-based corporate culture (and non-English-speaking potentially) into your own company’s culture.   Even in the case of an acquisition between two U.S. based companies, the integration of corporate cultures is hard.  That difficulty is only magnified when dealing with an acquiring company in one country and a target company in another. These human-based realities can derail the acquisition integration and create havoc in post-acquisition performance. You don’t want team members becoming distracted from the business, customer confusion in the marketplace, and employee attrition, all of which can negatively impact financial performance and the success of your acquisition. Don’t underestimate the challenge of cross border cultural integration.

If you need an experienced team to help you execute one of these “private to private” acquisitions or an acquisition of a foreign-owned entity, reach out to FLG. Our partners have executed over 300 deals over the last 2 decades. We’re happy to assist.

Kenton Chow

Kenton Chow joined FLG in 2015 and has over 25 years of CFO experience as both a CFO,  COO & Board member of various private and public technology companies, including software, fintech, biometric identification, big data analytics, IoT, e-commerce, security, retail, networking, and computer systems. Kenton (Ken) adds value to companies by leveraging…Read More