Management for Professionals

Maximilian Dreher
Dietmar Ernst

Mergers &
Acquisitions
Understanding M&A Processes
for Large- and Medium-Sized
Companies
Management for Professionals
The Springer series Management for Professionals comprises high-level business
and management books for executives. The authors are experienced business
professionals and renowned professors who combine scientific background, best
practice, and entrepreneurial vision to provide powerful insights into how to achieve
business excellence.
Maximilian Dreher • Dietmar Ernst

Mergers & Acquisitions

Understanding M&A Processes for
Large- and Medium-Sized Companies
Maximilian Dreher Dietmar Ernst
MBG Mid-Market Investment Company University of Nürtingen-Geislingen (HfWU)
Baden-Württemberg Nürtingen, Germany
Stuttgart, Germany

ISSN 2192-8096 ISSN 2192-810X (electronic)

Management for Professionals
ISBN 978-3-030-99841-7 ISBN 978-3-030-99842-4 (eBook)
https://doi.org/10.1007/978-3-030-99842-4

Translation from the German language edition: “Mergers & Acquisitions” by Maximilian Dreher and
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Preface

In view of increasing globalization and the associated internationalization of

markets, companies of all sizes are facing growing competition. Opening of new
markets, such as Asia, South America, or Eastern Europe, dismantling of traditional
barriers to market entry, and saturation of domestic markets are pushing companies
to take the initiative. It is not the big that eats the small, but the fast that eats the slow
(Furtner, 2011, p. 20).
Nowadays, mergers and acquisitions (M&A) are an essential instrument of
strategic corporate management for various companies. The credo is to grow faster
and stronger than the competition thanks to inorganic growth. The phenomenon is
making M&A not only a part of the standard repertoire of corporate executives but is
also becoming increasingly important in the minds of medium-sized companies.
What has been initially an exclusive country club for large-scale entrepreneurs, has
long since been identified by decision-makers in the SME sector as an important
growth element. Those who see M&A merely as a spare-time activity and not as a
duty, miss the significance of this instrument with this assessment.
Company mergers and acquisitions are highly complex and time-consuming
projects initiated, for example, by growth desires, restructuring, or succession
planning. Due to numerous endogenous and exogenous influences, no two M&A
transactions are alike at the detailed level. Although there is no patent remedy to
follow in connection with a merger or acquisition, orientation to established process
milestones helps those involved in the transaction to significantly increase the
chances of success.
Despite the increasing importance of M&A transactions, around 56% of all
mergers and acquisitions turn out to be failures (Wirtz, 2012, p. 7). “Therefore,
test who binds himself eternally, whether the heart finds its way to another heart! The
delusion is short, the regret is long,” reads Friedrich Schiller’s poem “The Song of
the Bell” (1799), in which he warned against blind euphoria when choosing a
spouse. Many corporate leaders do not seem to realize that these wise words apply
not only to the marriage of two people. In 1998, for example, the merger of Daimler-
Benz AG with Chrysler Corporation was initially celebrated as a historic event.
However, after 2 years this marriage was already in crisis and in 2007 the divorce
was finally executed. The case of Daimler-Chrysler is one of many failed corporate
transactions. However, such wrong decisions are not only made in large companies,

v
vi Preface

but also in medium-sized businesses. In medium-sized companies, however, the

failure of corporate transactions can be existentially threatening.
The success of an M&A project depends to a large extent on optimal transaction
preparation, fast transaction execution and the experience of the parties involved.
Anyone who ventures into a transaction unprepared and fails to recognize the
momentum will have to pay dearly for this later. The process must therefore be
carefully prepared and executed by both buyer and seller.
“In the end, we retain from our studies only what we can practically apply.” In
accordance with this quotation from Johann Wolfgang von Goethe, this book is
designed as a practical M&A guide. In addition to dealing with important
fundamentals regarding Mergers and Acquisitions, the main focus is on a structured
and well-founded examination of the individual process steps of a typical sale of a
company. In the process, specific differences between the sale of medium-sized
companies (mid-caps), and large-sized companies (large-caps) are discussed.
It should also be highlighted that M&A is part of the tools of the trade for both
large- and medium-sized companies, and both groups should take “(. . .) M&A as a
weapon for competitive advantage” (Harding et al., 2013, p. 8).
We would like to thank the publisher Springer Nature for tackling this exciting
topic together with us. Miss Rocio Torregrosa and Mister Parthiban Gujilan Kannan
from Springer Nature has supported us professionally in all steps of the book
production, for which we thank her/him very much. If you have any questions,
suggestions, criticism (and praise, too), please feel free to contact us at [email protected].
We wish all readers an interesting and insightful read.

Stuttgart, Germany Maximilian Dreher

Nürtingen, Germany Dietmar Ernst

References

Furtner, S. (2011). Management von Unternehmensakquisitionen im Mittelstand.

Erfolgsfaktor Post-Merger-Integration (2nd ed.). LINDE.
Harding, D., Shankar, S., & Jackson, R. (2013, January 16th). (Bain & Company,
Editor) Retrieved February 1st, 2022, from www.bain.com: https://www.bain.
com/insights/the-renaissance-in-mergers-and-acquisitions/
Wirtz, B. (2012). Mergers & Acquisitions Management. Strategie und Organisation
von Unternehmenszusammenschlüssen (2nd ed.). Springer Gabler.
Contents

1 The Foundation of the Consideration . . . . . . . . . . . . . . . . . . . . . . . 1

1.1 The Term “Mergers and Acquisitions” . . . . . . . . . . . . . . . . . . . . 1
1.2 The Market for Mergers and Acquisitions . . . . . . . . . . . . . . . . . . 3
1.2.1 The Phenomenon of US Merger Waves . . . . . . . . . . . . . . 3
1.2.2 Current Developments in the M&A Market . . . . . . . . . . . 4
1.3 Strategy Development in the Context of M&A Projects . . . . . . . . 5
1.3.1 Motives for M&A Transactions . . . . . . . . . . . . . . . . . . . 5
1.3.2 Takeover Techniques . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
1.3.3 Goals in an M&A Process . . . . . . . . . . . . . . . . . . . . . . . 8
1.3.4 Types of Company Acquisition . . . . . . . . . . . . . . . . . . . . 8
1.3.5 Common Success and Failure Factors of M&As . . . . . . . 10
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
2 David and Goliath: Mid-cap and Large-cap Companies . . . . . . . . . 15
2.1 Medium-sized Companies (Mid-caps) . . . . . . . . . . . . . . . . . . . . 15
2.2 Large Companies (Large-caps) . . . . . . . . . . . . . . . . . . . . . . . . . 16
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
3 M&A Sales Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
3.1 Phase I: Preparation Phase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
3.1.1 From the Sales Idea to the Starting Signal . . . . . . . . . . . . 20
3.1.2 The Starting Signal: Beauty Contest . . . . . . . . . . . . . . . . 28
3.1.3 Mandate Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
3.1.4 Selection of a Suitable M&A Procedure . . . . . . . . . . . . . 33
3.1.5 Comprehensive Data Collection and Company Analysis . . 37
3.1.6 Buyer Universe and Identification of Suitable Buyers . . . . 40
3.1.7 Documentation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
3.2 Phase II: Market Approach: Point of No Return . . . . . . . . . . . . . 54
3.2.1 Addressing Potential Buyers . . . . . . . . . . . . . . . . . . . . . . 54
3.2.2 Letter of Intent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55
3.2.3 Selection of Preferred Potential Buyers . . . . . . . . . . . . . . 56
3.2.4 Checklist: Letter of Intent . . . . . . . . . . . . . . . . . . . . . . . . 57
3.3 Phase III: Examination of Financial Aspects . . . . . . . . . . . . . . . . 57
3.3.1 Due Diligence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58

vii
viii Contents

3.3.2 Company Valuation . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72

3.3.3 Structuring of the Transaction . . . . . . . . . . . . . . . . . . . . . 87
3.4 Phase IV: Closing Phase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111
3.4.1 Contract Negotiations . . . . . . . . . . . . . . . . . . . . . . . . . . . 112
3.4.2 Binding Offer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113
3.4.3 Purchase Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . 114
3.4.4 Closing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115
3.4.5 Differences in the Closing Phase of a Sales Transaction
for Medium-sized Companies and Large Companies . . . . 116
3.4.6 Checklists: Contract Negotiations, Signing, and Closing . . 117
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117

Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121
Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123
Abbreviations

ABS Asset Backed Securities

APV Adjusted Present Value
BATNA Best Alternative To a Negotiated Agreement
Capex Capital Expenditure
CAPM Capital Asset Pricing Model
CBO Corporate Buy-Out
CBR Confidential Business Report
CEO Chief Executive Officer
CFO Chief Financial Officer
CFtE Cash Flow to Equity
DCF Discounted Cash Flow
DD Due Diligence
EBIT Earnings before interest and taxes
EBITDA Earnings before interest, taxes, depreciation and amortization
EqV Equity Value
EU European Union
EURm Millions in Euro
EV Enterprise Value
IFRS International Financial Reporting Standards
IM Information Memorandum
IPO Initial Public Offering
IRR Internal Rate of Return
KPMG Klynveld, Peat, Marwick und Goerdeler
LBO Leveraged Buy-Out
LOI Letter of Intent
Ltd. Limited liability company
M&A Mergers and Acquisitions
MAC Material Adverse Changes
MBI Management Buy-In
MBO Management Buy-Out
n.a. not available
NDA Non-Disclosure Agreement
NewCo New Company

ix
x Abbreviations

oFCF Operating Free Cash Flow

Plc. Public limited liability company
PMI Post-Merger-Integration
PwC PricewaterhouseCoopers
ROI Return on Investment
SME Small and medium sized enterprises
SPC Special Purpose Company
SPV Special Purpose Vehicle
SWOT Strengths, Weaknesses, Opportunities, Threats
USA United States of America
USD United States Dollar
USDm Million United States Dollar
US-GAAP United States Generally Accepted Accounting Principles
USPs Unique Selling Propositions
VDD Vendor Due Diligence
WACC Weighted Average Cost of Capital
List of Figures

Fig. 1.1 Business combinations (Own representation based on Wirtz,

2012, p.13) . .. . . . . . . . . . . .. . . . . . . . . . . . .. . . . . . . . . . . .. . . . . . . . . . . . .. . . . . . . . . . 2
Fig. 3.1 Four phases of an M&A sales process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Fig. 3.2 M&A sales procedures . . . .. . . . . . .. . . . . .. . . . . . .. . . . . .. . . . . . .. . . . . .. . . . . . 34
Fig. 3.3 Valuation methods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
Fig. 3.4 Valuation multiples .. .. . .. .. . .. .. . .. .. . .. .. . .. .. . .. .. .. . .. .. . .. .. . .. .. . . 77
Fig. 3.5 Summarized representation of a company valuation
(excl. LBO analysis) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84
Fig. 3.6 Simplified acquisition structure for a direct acquisition
with liability recourse to the buyer .. . .. .. . .. . .. .. . .. . .. .. . .. . .. . .. .. . . 93
Fig. 3.7 Simplified acquisition structure for an indirect acquisition
without liability recourse (non-recourse) to the buyer . . . . . . . . . . . . . . 95
Fig. 3.8 Financing instruments used for acquisition financing . . . . . . . . . . . . . . . 99

xi
List of Tables

Table 1.1 Seller’s perspective .. . .. .. .. . .. .. . .. .. . .. .. . .. .. . .. .. . .. .. . .. .. .. . .. . 9

Table 1.2 Buyer’s perspective . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Table 2.1 Definitions of medium-sized companies . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Table 2.2 Definitions of large companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Table 3.1 Global ranking of M&A financial services advisors in H1 2020
(by cumulative deal volume) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Table 3.2 M&A boutiques in Germany . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Table 3.3 Global ranking of M&A legal advisors in H1 2020
(by cumulative deal volume) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Table 3.4 Typical criteria for MBOs and MBIs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
Table 3.5 Advantages and disadvantages of a silent partnership . . . . . . . . . . . 44
Table 3.6 Advantages and disadvantages of an open-ended investment
from the perspective of the target company . . . . . . .. . . . . . . . . .. . . . . . 44
Table 3.7 Advantages and disadvantages of selling the company to
a strategic investor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
Table 3.8 Simplified representation of enterprise value calculation in the
context of a trading multiples valuation . . . . . . . . . . . . . . . . . . . . . . . . . . . 79
Table 3.9 Simplified representation of the enterprise value multiples
calculation in the context of a transaction multiples
valuation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80
Table 3.10 Equity mezzanine and debt mezzanine instruments . . . . . . . . . . . . . . 103

xiii
The Foundation of the Consideration
1

This chapter clarifies the following questions:

• What is meant by mergers and acquisitions?

• Which developments have taken place in the American M&A market?
• Which current developments can be observed in the global M&A market?
• What strategic considerations are necessary prior to an M&A transaction?

1.1 The Term “Mergers and Acquisitions”

" Definition In general, there is no standardized definition of the term mergers and
acquisitions in today’s literature or practical use. In the following, an understanding
of this term will therefore be created on the basis of selected definitions (see also
Fig. 1.1).

1. Mergers and acquisitions (M&A) are mergers and acquisitions of companies or

their divisions or subsidiaries (Wirtz, 2012, p. 11).
2. The term merger describes the amalgamation of two independent companies to
form a single economic and legal entity. An acquisition represents the purchase of
a previously independent company or part of a company. In the course of an
acquisition, the target company loses its economic independence, but not neces-
sarily its legal independence.
3. M&A—in German, the merger of companies and acquisition of companies or
shares in companies—stands for all transactions relating to the transfer and
encumbrance of ownership rights in companies, including the formation of
groups, restructuring of groups, mergers and, conversions in legal sense,
squeeze-outs, financing of the acquisition of companies, formation of joint
ventures and acquisition of companies (Mohr & Bärtl, 2012, p. 238).
4. The term Mergers and Acquisitions (M&A), which originates from U.S. invest-
ment banking, describes the trading (purchase/sale) of companies, parts of

# The Author(s), under exclusive license to Springer Nature Switzerland AG 2022 1

M. Dreher, D. Ernst, Mergers & Acquisitions, Management for Professionals,
https://doi.org/10.1007/978-3-030-99842-4_1
2 1 The Foundation of the Consideration

Business combinations
(in the broader sense)

Business combinations
Business cooperation
(in the narrow sense)

Joint
Acquisition Merger Strategic alliance
Venture

The companies lose their economic and usually The companies cooperate on a voluntary basis
legal independence. and remain legal independence as well as
economic independence in the business areas
not affected by the cooperation.

Fig. 1.1 Business combinations (Own representation based on Wirtz, 2012, p.13)

companies, and interests in companies and is translated as mergers and

acquisitions. In a broad version, it also includes cooperation (joint ventures,
alliances, etc.) (Wirtz, 2012, p. 11).
5. “M&A is a careful blend of art and science. On one hand, it is multidisciplinary,
complex, and analytical. On the other, it is all about people, relationships,
nuances, timing, and instinct. This dynamic blend produces opportunity coupled
with conflict, ambiguity, and challenges, all supporting an exhilarating business
ripe for those seeking to create value” (Marks et al., 2012, p. XVIII).

To describe an M&A process, the following two approaches have proven useful
in practice:

• Business approach
• Service approach

Under the business approach, an M&A process is described from the point of
view of trading companies. This view is mainly represented in the Anglo-
American area.
On the other hand, in German-language literature, the service approach has
become established. It describes services offered by investment banks, M&A
boutiques, law firms, and accounting firms (Ernst & Häcker, Applied International
Corporate Finance, 2011, p. 2).
1.2 The Market for Mergers and Acquisitions 3

1.2 The Market for Mergers and Acquisitions

Mergers and Acquisitions have a long tradition, especially in the USA. As early as
the time of the industrial revolution, numerous corporate transactions were
concluded. Today this trend is continuing on a global scale.

1.2.1 The Phenomenon of US Merger Waves

The market for M&A is characterized by the periodic appearance of upswings and
downswings. Similar to economic cycles, M&A activity over the past 100 years has
also moved in waves. Although the individual merger waves have different drivers,
triggers have historically always been external shocks that created adjustment
pressure in affected industries and markets (Behringer, 2013, p. 40). The upswings
in individual waves are usually due to economic changes, political decisions, or
technical innovations. The downturns, on the other hand, are a result of economic
crises and recessions in the global economy (Jansen, 2008, p. 131).
1. First wave: The first wave of mergers took place toward the end of the nineteenth
century, primarily in the USA. The driving force behind this movement was the
industrial revolution. It led to a large wave of predominantly horizontal mergers
in heavy industry, to avoid overcapacity and price degression (Wirtz, 2012,
p. 96).
2. Second wave: The second wave of M&A in the 1920s (the so-called roaring
twenties) was triggered by new anti-trust laws and an economic upswing. This
was followed by numerous vertical integrations of companies upstream or down-
stream in the value chain. The subsequent downturn was a consequence of the
global economic crisis of 1929 (starting point: so-called black Friday), which led
to a decline of 85% of M&A transactions within 1 year (Wirtz, 2012, p. 96).
3. Third wave: In the 1960s, the next M&A wave could be identified, characterized
by acquisitions in the energy and industrial mass production sectors. This time,
the trigger was the companies’ desire for portfolio expansion and diversification.
As a result, several broad-based conglomerates emerged (Wirtz, 2012, p. 97).
4. Fourth wave: The fourth wave of M&A occurred in the 1980s and is also referred
to as merger mania. The driving forces were the liberalization of monopoly and
tax laws and the positive economic outlook of the future. Numerous horizontal
corporate mergers took place as companies exploited the synergy potential.
Another feature of this wave was a high number of hostile and highly leveraged
takeovers for the first time (Wirtz, 2012, p. 97).
5. Fifth wave: The fifth wave of M&A was triggered by increasing economic
globalization, accompanying competitive and technological changes. It took
place in the 1990s and, unlike previous waves, was particularly characterized
by mega-deals, such as the merger of Daimler-Benz and Chrysler, which was a
major factor. Also, the hype surrounding so-called dot-com companies played a
major role. With the end of new economy, this wave also started to decline again
(Wirtz, 2012, pp. 97–98).
4 1 The Foundation of the Consideration

6. Sixth wave: From 2002 to 2007, the sixth wave of M&A was identified. It was
fueled by a deregulated world and financial markets and was supported by a
recovery of the global economy and positive development of emerging markets.
The main players in this phase were primarily institutional investors (e.g., private
equity and hedge funds), which financed a lion’s share of global transactions. The
bursting of the credit bubble in the real estate market in 2007 marked the end of
this wave of M&A and led to a widespread credit crunch in numerous markets
(Wirtz, 2012, p. 98).
7. Seventh wave: Officially, there is no talk of the seventh wave of M&A, but there
are clear signs of it. Advancing globalization, new technologies, and at the same
time, bulging war chests of various companies are already foreshadowing a
seventh M&A wave (Furtner, 2011, p. 16).

Finally, we list three important findings in connection with the observed M&A
waves (Furtner, 2011, p. 17):

• The depression phases between each M&A wave become steadily shorter.
• The rises at the beginning and the falls after each wave are very steep.
• The duration of individual M&A waves is getting shorter and shorter.

1.2.2 Current Developments in the M&A Market

The German market for corporate acquisitions and mergers still remains less devel-
oped than in the USA or the UK. The global transaction volume for M&A
transactions amounted to 3330 billion U.S. dollars in 2008, of which 32.4% was
attributable to the USA and only 5.3% to Germany (Kunisch, 2009, p. 48). Further-
more, the M&A market in Germany is a relatively recent phenomenon. While the
USA saw an initial surge in M&A activity as early as in the end of the nineteenth
century, the market for M&A in Germany did not begin to develop until reunifica-
tion. Mainly in 1999 and 2000, big deals such as Vodafone-Mannesmann or
Daimler-Chrysler took center stage. However, the market for M&A in Germany
almost collapsed just 2 years later, until finally in 2005 an increasing transaction
volume was observed again (Raupach, 2007, p. 204).
The financial crisis caused a downward trend from mid-2007, which intensified
dramatically in 2008. The downward trend reached its low point in mid-2009. This
trough was passed in 2010 with regard to M&A activities at the global level,
whereupon business with mergers and acquisitions picked up again (Spanninger,
2011, pp. 49–51).
The year 2015 was one of the best-performing years in terms of M&A transaction
volume achieved. The total volume of M&A deals announced worldwide in 2015 set
a new record of approximately USD 3800 billion (since 2007) and exceeded the
already high prior-year figure of USD 3600 billion (Baigorri, 2016).
In the first half of 2020, 6938 M&A transactions with a total volume of approxi-
mately USD 901.5 billion were completed at the global level. Compared to the first
1.3 Strategy Development in the Context of M&A Projects 5

half of 2019, this corresponds to a decrease in deals by approximately 32% and

cumulative transaction volume by 52.7%. This significant decrease in 2020 is due to
the global impact of the COVID-19 pandemic. For many companies, liquidity
management is currently essential and investment projects, which include M&A
transactions, are being postponed to a later date. As soon as the Corona crisis
subsides, experience shows that M&A activity should pick up again as a result of
decreasing company valuations (Mergermarket, 2020, p. 5).

1.3 Strategy Development in the Context of M&A Projects

In order to develop a comprehensive understanding of M&A projects, it is important

to know strategic considerations in the run-up to a transaction. What motives guide
M&A actors? What acquisition techniques are available to buyers? What are the
different types of corporate acquisitions? Why do M&A transactions fail and why do
others succeed? These questions are addressed in the following sections.

1.3.1 Motives for M&A Transactions

Business combinations result from the merger of two or more legally and economi-
cally independent companies to form larger economic entities (Ernst & Häcker,
2011, p. 2). The elaboration of typical motives for corporate takeovers is highly
dependent on the specific situation. Depending on the plans and strategy of the buyer
or seller, various reasons are decisive for an acquisition or divestment.
A selection of crucial sales motifs is presented below:

• Multinationals are seeking to focus on their core business and are selling off parts
of the company or subsidiaries.
• A widespread reason for selling family businesses, which include a large propor-
tion of SMEs, is unclear succession planning. If no suitable successor is available
within the family or the existing management of the company founder, the
company is usually put up for sale in the market.
• In the context of investment financing, a medium-sized company often has no
choice but to transfer the company to larger groups or competitors or to merge
with other medium-sized companies. The reason for this is a usually low capitali-
zation of the SMEs (Wirtz, 2012, p. 5).
• After a short holding period, investment companies look for an exit and want to
sell their holdings in the company again.
• Heavily entrenched conflict situations between shareholders, such as a divorce
between two shareholders, can also mean a company sale is the best option for the
company’s continued existence (Sattler, 2010, p. 21).

As is the case with company sellers, there are numerous M&A motives that
induce potential acquirers to enter into an M&A project:
6 1 The Foundation of the Consideration

• Accelerating sales growth is a frequent driver for corporate acquisitions (RBS

Citizens Financial Group, 2012, p. 10). Instead of a long-term organic growth
path, the size of the company can therefore often be expanded more quickly
through acquisitions than by building new structures.
• Expanding geographic presence and entering new markets are other acquisition
motives. Companies in Germany and Austria, for example, are seen as the
gateway to Eastern Europe. This prompts companies around the world willing
to expand to acquire companies from these countries, for example, to save
themselves the trouble of setting up their own distribution network.
• High levels of competition encourage companies to expand their market power by
increasing their market share. This can secure their market position and reduce
competitive pressure. In the most extreme form, this can lead to monopolistic
structures (Jansen, 2008, p. 171) (Behringer, 2013, p. 43).
• Access to specialized know-how and new technologies represents a further
acquisition motive. If a company has unique technologies or special know-how,
e.g., in the area of research and development, research and development, it can be
a great advantage for an acquiring company to acquire these resources through a
takeover instead of developing them internally through a process lasting many
years.
• A frequently cited driver in the context of a company acquisition is the realization
of synergy effects. Cost synergies are realized, for example, through economies
of scale and economies of scope. The costs of realizing various synergy potentials
are often greatly underestimated. The greater the depth of integration between two
companies, the greater the share of costs for synergy realization will be
(Timmreck & Bäzner, 2012, p. 110).
• Depending on the strategy, motives relating to production, the product portfolio,
risk distribution, or taxes also come to the fore.

1.3.2 Takeover Techniques

A distinction with regard to the takeover technique makes sense primarily in the case
of listed corporations, since their company shares are often freely traded on the
respective stock exchanges. An important feature of such companies is the separa-
tion of ownership and management functions (Wirtz, 2012, p. 22). A corporate
takeover can be either friendly or hostile in nature. Even if the majority of
shareholders would approve a takeover, the tipping point is an approval or a
disapproval by the target company’s management.

1.3.2.1 Friendly Takeover

" Definition A friendly takeover is one in which the management of the target
company approves the change of ownership (Wirtz, 2012, p. 22).
1.3 Strategy Development in the Context of M&A Projects 7

In contrast to a hostile takeover, the incentive for a friendly takeover can come from
both the buyer and the seller. The seller usually prefers to sell the target company in
an auction process. This has the advantage that there are several bidding parties and a
higher selling price can be achieved. From the buyer’s point of view, friendly
takeovers are often more successful than hostile ones, as the management of the
target company cooperates with the buyer and gives the latter the opportunity for
detailed due diligence (Achleitner, 2002, p. 195).

1.3.2.2 Hostile Takeover

" Definition A hostile takeover is an attempted takeover that is carried out against
the will of the target company’s management (Hölters, 2005, p. 37).

In Germany, at least not because of the strong medium-sized and owner-oriented

corporate structure, so-called hostile takeovers were hardly represented until a few
years ago. Also, the public attitude in Germany toward such M&A projects was
rather negative. Since the successful takeover of Hoesch AG by Krupp AG (1991)
and the attempted takeover of Thyssen AG by Krupp AG (1997), hostile M&A
transactions have gained importance in Germany. One of the most spectacular cases
of a hostile takeover was the takeover battle between Mannesmann and Vodafone,
which ended in the purchase of Mannesmann by Vodafone.
A hostile takeover is often initiated by a tender offer. This is understood to mean a
public takeover offer of limited duration by prospective acquirers, which is
addressed directly to the shareholders of the target company. To make the offer
more attractive to current shareholders, public takeover offers often contain a high
premium on the current stock market price of the target company (Wirtz, 2012,
p. 23).
To protect itself against a hostile takeover, the target company may take the
following preventive defensive measures, among others (Trunk, 2010, p. 94):
• Share buybacks: In Germany, the share buyback under Section 71 of the German
Stock Corporation Act “Acquisition of own shares” is possible up to 10% of the
share capital. This increases the share price and makes the target more expensive.
Besides, the cash balance decreases or the debt increases, making the target
company less attractive from a buyer’s point of view.
• Poison Pills: Existing shareholders of the target company have the right to
purchase a certain number of shares in the target company at a discounted price
in an event of a takeover. The conversion of non-voting preferred shares into
shares with voting rights is also conceivable.
• Poison Put: There are contracts with the lenders of the target company which
stipulate immediate repayment of loans as soon as control of the target company
changes.
• Staggered Board: The contracts of the Supervisory Board and Executive Board
members are staggered over time. This makes it more difficult for the hostile
acquirer to replace the existing management and control body.
8 1 The Foundation of the Consideration

• Golden Parachutes: In the event of a hostile takeover, oversized special payments

to the management of the target company can be agreed upon. This can make it
too costly for the potential acquirer to gain control by replacing the existing
management. However, a clear principal–agent conflict can be identified here.

The hands of the existing management of the target company are not tied even if
the hostile takeover bid has already been addressed to the shareholders. Rather, it is
possible to implement certain ad hoc defense measures, which are listed below
(Trunk, 2010, pp. 94–95):

• Crown Jewels: The target company sells particularly attractive and lucrative
business units (jewels) to a friendly company or carries out a spin-off. This can
eliminate synergy potential from the perspective of the hostile acquirer and make
the hostile takeover unattractive. However, this measure jeopardizes the corporate
existence of the target company to a high degree.
• Asset Restructuring: The target company acquires assets that a hostile acquirer is
highly unlikely to want or which may cause antitrust problems during the course
of a takeover.
• White Knight: A friendly company makes a higher takeover bid and thus drives
up the purchase price. In addition to a majority shareholding, this white knight
can also provide the target company with sufficient funds as an alternative to
prevent a hostile takeover.

1.3.3 Goals in an M&A Process

In addition to the motives for a corporate transaction, the objectives of two main
players (buyer and seller) also play a decisive role in the M&A process. Since a seller
usually pursues objectives that differ from those of the buyer, it is essential for both
parties to know the respective objectives of their counterparts. In this way, both
parties to the transaction can position themselves optimally in the M&A process. The
most important objectives from the seller’s and buyer’s point of view are listed
below (Mohr & Bärtl, 2012, p. 240) (see Tables 1.1 and 1.2):

1.3.4 Types of Company Acquisition

In general, the acquisition of a company can be executed in two ways. On one hand,
the buyer can acquire shares in the company for sale. In this case, it is referred to as a
share deal. On the other hand, the subject of corporate transaction may also include
all or certain assets and rights of a target company. This scenario is referred to as an
asset deal. Both types of acquisition are described below.
1.3 Strategy Development in the Context of M&A Projects 9

Table 1.1 Seller’s perspective

Purchase price • Maximizing purchase price
Confidentiality • Selection of M&A procedure
• Identification of the correct buyer
• Protection of confidentiality
Execution speed • Competitive environment
• Minimal impact on operational daily business
Process and transaction • Quality of execution
security • Security of funding
• Closing conditions
Risk mitigation • Well-guided and structured process
• Seller-favoring warranties in the contractual framework
Decisive success criterion • Keeping up competition among at least two bidders until the
end

Table 1.2 Buyer’s perspective

Purchase price • Minimizing purchase price
Confidentiality • Confidentiality agreement with minimum liability and long-
term commitments
Execution speed • Fast deal closing
• Minimizing transaction cost
Process and transaction • Ideal financing structure
security
Risk mitigation • Positioning as best potential bidder
• Buyer-favoring warranties in the contractual framework
Decisive success criterion • Exclusivity during auction process
• Avoidance of counteroffers during bilateral processes

1.3.4.1 Share Deal

" Definition In a share deal, shares in a company are sold in their entirety, as a
majority or as a minority. The object of the transaction is therefore the shares in the
company. By transferring the shares to a new owner, the identity of the target
company remains unaffected or the target company continues to exist as a legal
entity (Wirtz, 2012, p. 286). Consequently, a transfer of assets and liabilities is not
necessary (Jaques, 2012, p. 10).

Company sellers often prefer the share deal because, in contrast to an asset deal, all
rights and obligations of the seller are transferred to the buyer in a complete sale.
Accordingly, in addition to all assets and liabilities, all known and unknown risks are
also assumed by the buyer. As a result, in the course of a share deal, the buyer insists
on the seller providing comprehensive guarantees in order to take account of the
information asymmetry.
10 1 The Foundation of the Consideration

From a tax point of view, the acquisition of shares in corporations (Ltd., Plc.) is of
particular importance. There are attractive options such as transferring the purchase
price to the future depreciation volume or deducting financing costs.

1.3.4.2 Asset Deal

" Definition One speaks of an asset deal when the buyer does not purchase the
legal entity of a company, but only certain assets (Mohr & Bärtl, 2012, p. 241).

In this type of company purchase, the buyer acquires individual assets, intangible
assets, and liabilities of the purchased company. The acquired assets are transferred
to the balance sheet of the buyer company and, after the withdrawal of the purchase
price by existing shareholders, an empty company shell remains on the seller side.
Depending on the circumstances, this shell can subsequently be liquidated, sold, or
used for new legal transactions.
In an asset deal, unlike in a share deal, not all rights and obligations are
transferred to the buyer, but only to the owner of active and passive assets listed in
the purchase agreement (Mohr & Bärtl, 2012, p. 241).
In terms of advantages, corporate buyers often prefer this type of company
acquisition. The newly acquired assets can be transferred by the purchaser directly
to the purchaser’s balance sheet with the release of hidden reserves and, together
with any goodwill paid, can be amortized on a scheduled basis in subsequent years.
This additional amortization leads to an improvement in future cash flows on the
buyer side. Also, the acquired assets can be used as collateral for debt financing
(Mohr & Bärtl, 2012, p. 286).

1.3.5 Common Success and Failure Factors of M&As

As already mentioned, around 56% of all mergers and acquisitions turn out to be
failures in retrospect (Wirtz, 2012, p. 7). Furthermore, the following also applies in
the area of mergers and acquisitions: “Ignorantia iuris nocet (Latin saying for
‘ignorance does not protect against punishment’).” In order to spare companies
willing to sell or buy from the disadvantages of an M&A project—too high or too
low a purchase or sales price, failure to recognize risks, termination of the transac-
tion, failure to achieve planned synergies—the most common success and failure
factors of corporate transactions are discussed below.

1.3.5.1 Success Factors of Corporate Transactions

Probably the most important success factor in M&A projects is the experience of
those involved. If experienced managers and consulting specialists are involved in a
transaction process, this significantly increases the success of an M&A project. As
the number of corporate transactions increases, a company is generally in a better
position to evaluate an M&A project, to structure and carry out due diligence, to
complete the merger (post-merger integration), and thus to realize planned synergies.
1.3 Strategy Development in the Context of M&A Projects 11

Essentially, M&A experience enables managers and consulting specialists to act

swiftly and efficiently when problems arise in the M&A process, thanks to the
problem-solving skills they have gained (Furtner, 2011, p. 48). Thus, it is also true
in the M&A business that practice makes perfect.
Another success factor of corporate transactions is the strategic fit between buyer
and seller. This term denotes the harmony or fit between buying and selling
companies. The more different the two companies are, the more difficult the merger
and thus more complex the M&A project will be. Factors influencing the strategic fit
include:
• Company vision
• Company size
• Corporate culture
• Business areas of both companies
• Cultural similarities and differences

As a rule, the greater the strategic fit, the more successful the corporate transac-
tion. Acquisitions that demonstrate a high degree of fit with the buyer’s core
activities and allow the buyer to expand into new geographic markets prove to be
particularly successful (Behringer, 2013, pp. 366–367).
A third factor for success is the employees and management of the sold company.
If many employees remain with the company following the corporate transaction,
the success of the M&A project is often higher than if there is a high level of
employee churn after the transaction is completed. At this point, however, a classic
conflict of objectives arises, since various synergy effects can regularly only be
realized by laying off employees. In terms of management, a familiar management
team often has a positive influence on employee morale in the aftermath of an M&A
transaction and also proves very helpful in the day-to-day operations of the acquired
company. Keeping the old management or parts of the old management after the
acquisition can contribute to a considerable stabilization of the acquired company
(Behringer, 2013, pp. 368–370).

1.3.5.2 Failure Factors of Corporate Transactions

In retrospect the actual successes of M&A transactions are very often lower than
expected because either the strategic considerations are already misguided, too high
purchase prices are paid, or the hoped-for synergies do not materialize or are
overcompensated by integration and coordination costs (See & Heinzelmann,
2012, p. 7).
If you only look at money, your M&A project will also reach its limits in the long
term. If a company decides purely based on financial motives, such as shareholder
value satisfaction or the financial self-interest of top management (through partici-
pation in sales and share price developments), then this plan is often not particularly
successful. The purely financial focus is mostly a driving force of the short-term
corporate view and corporate development and thus not a suitable goal for the long-
term continuation of the company. Successful corporate mergers are those in which
strategic goals have a priority position over financial goals (Furtner, 2011, p. 26).
12 1 The Foundation of the Consideration

An excessive price expectation on part of the seller is a further failure factor of

several corporate transactions. One reason for this can be a company valuation
carried out by M&A consultants, whose company value is inflated and thus attractive
for the seller, to possibly initiate the transaction and position themselves as M&A
sales consultants. A second reason for too high price expectations of the seller is to
be found in his emotional attachment to his own company. In most cases, companies
are more than just businesses to the owners. They are often lifeworks. Therefore,
entrepreneurs often do not recognize problems or weak points of their company or
recognize them insufficiently and are convinced that their company must achieve the
absolute highest transaction value in a sale. If seller and buyer come to the
negotiating table in both cases—company valuation and emotional attachment—it
is difficult to agree on a fair price. The company sale would thus be on the verge of
failure (Sattler & Seng, Unternehmensverkauf, 2010, p. 83).
Since M&A is often referred to as the supreme discipline of business administra-
tion, it is hardly surprising that managers and shareholders involved sometimes
make irrational and emotional decisions because of the hoped-for subsequent pres-
tige. “In the End, M&A is a flawed process, invented by brokers, lawyers, and
supersized, ego-based CEOs” (Harding et al., 2013, p. 1). Thus, in some cases,
corporate transactions are carried out for which there are no explanations from a
rational point of view. Such wrong decisions are made not only by large corporations
but also by medium-sized companies. The triggers are usually vanity, striving for
power, and overestimation of one’s capabilities (hubris) on the part of the managers
authorized to make decisions. As a result, these corporate transactions are usually
doomed to failure.
Different corporate cultures and cultural aspects, in general, can also significantly
limit or eliminate the success of a transaction. Particularly in post-merger integra-
tion, almost insurmountable barriers may come to light that has a negative impact on
a business combination (Furtner, 2011, p. 27).
For an entrepreneur, the sale of a company is usually a one-time event. Often, the
decision to sell is made at short notice and the seller only allows a short period of
time until the transaction is completed. In other words, the complexity of corporate
transactions and the time involved are often underestimated. If, for example, a
medium-sized entrepreneur decides to sell a company, he often only realizes during
the course of the transaction that precise planning, preparation, and execution of an
M&A project leads to a neglect of the operative day-to-day business. Without
sufficient understanding of M&A and the involvement of M&A specialists, this
conflict of objectives leads to a clear reduction in success (Sattler & Seng, 2010,
p. 81).
A pure focus on cost synergies also turns out to be a frequent failure factor. If the
main objective of an M&A transaction is the realization of cost synergies, these
transactions often turn out to be unsuccessful. The reason for this lies in the fact that
earnings potential and synergy effects are often overestimated and in various cases
cannot be realized at all or only after a long delay (Furtner, 2011, p. 27).
If one looks at a study on the M&A process written by Deloitte in 2012 (Reker &
Götzen, 2012, p. 27), the importance of the preparation and integration phase in the
References 13

transaction process has so far been underestimated by M&A players, whereas the
importance of the company valuation and negotiations has been overestimated. To
date, negative effects on resource allocation and process structuring can be derived
from this.
Finally, the success of an M&A project depends crucially on optimal transaction
preparation and rapid transaction execution. Anyone who ventures into a transaction
unprepared and fails to recognize the momentum will have to pay dearly for this
later. The process must therefore be carefully prepared and executed by both the
buyer and the seller.

References
Achleitner, A.-K. (2002). Handbuch investment banking (3rd ed.). Gabler.
Baigorri, M. (2016, January 5th). (Bloomberg, Editor) Retrieved February 1st, 2022, from https://
www.bloomberg.com/news/articles/2016-01-05/2015-was-best-ever-year-for-m-a-this-year-
looks-pretty-good-too
Behringer, S. (2013). Unternehmenstransaktionen. Basiswissen - Unternehmensbewertung - Ablauf
von M&A. Erich Schmidt.
Ernst, D., & Häcker, J. (2011). Applied international corporate finance (2nd ed.). Vahlen.
Furtner, S. (2011). Management von Unternehmensakquisitionen im Mittelstand. Erfolgsfaktor
Post-Merger-Integration (2nd ed.). LINDE.
Harding, D., Shankar, S., & Jackson, R. (2013, January 16th). (Bain & Company, Editor) Retrieved
February 1st, 2022, from www.bain.com: https://www.bain.com/insights/the-renaissance-in-
mergers-and-acquisitions/
Hölters, W. (2005). Teil I: Mergers & Acquisitions. In W. Hölters (Ed.), Handbuch des
Unternehmens- und Beteiligungskaufs (5th ed., pp. 1–193). Dr. Otto Schmidt.
Jansen, S. (2008). Mergers & Acquisitions. Unternehmensakquisitionen und -kooperationen. Eine
strategische, organisatorische und kapitalmarkttheoretische Einführung (5th ed.). Gabler.
Jaques, H. (2012). Einführung und Überblick über den Ablauf eines Unternehmensverkaufs. In
J. Ettinger & H. Jaques (Eds.), Beck’sches Handbuch Unternehmenskauf im Mittelstand
(pp. 1–17). C.H. Beck.
Kunisch, S. (2009, February 1st). (G. Müller-Stewens, Editor) Retrieved February 2nd, 2022, from
www.ma-review.de: https://www.alexandria.unisg.ch/50854
Marks, K., Slee, R., Blees, C., & Nall, M. (2012). Middle Market M&A: Handbook for investment
banking and business consulting. Wiley & Sons.
Mergermarket. (2020, July 2nd). Retrieved February 1st, 2022, from www.mergermarket.com:
https://www.mergermarket.com/info/global-and-regional-ma-report-1h20-including-league-
tables-financial-advisors
Mohr, P., & Bärtl, S. (2012). Mergers & Acquisitions: Die M&A Beratung. In H. Hockmann &
F. Thießen (Eds.), Investmentbanking (3rd ed., pp. 238–276). Schäffer-Poeschel.
Raupach, G. (2007). Das M&A Geschäft. In J. Hockmann & F. Thießen (Eds.), Investment Banking
(2nd ed., pp. 203–240). Schäffer-Poeschel.
RBS Citizens Financial Group (Ed.). (2012). Retrieved February 1st, 2022, from www.
citizensbank.com: https://www.citizensbank.com/pdf/MA_Outlook_2013.pdf
Reker, J., & Götzen, S. (2012, May). (Deloitte, Editor) Retrieved February 1st, 2022, from www.
deloitte.com: https://www2.deloitte.com/content/dam/Deloitte/de/Documents/Mittelstand/
MandA-im-Mittelstand.pdf
Sattler, A. (2010). Grundsätzliche Überlegungen zum Unternehmenskauf und -verkauf. In
A. Sattler, H. Broll, & S. Nüsser (Eds.), Unternehmenskauf und -verkauf, Nachfolgeregelung
(pp. 17–23). Verlag Wissenschaft & Praxis.
14 1 The Foundation of the Consideration

Sattler, A., & Seng, R. (2010). Unternehmensverkauf. In A. Sattler, H. Broll, & S. Nüsser (Eds.),
Unternehmenskauf und -verkauf, Nachfolgeregelung (pp. 61–84). Verlag Wissenschaft &
Praxis.
See, M., & Heinzelmann, N. (2012). (Deloitte, Editor) Retrieved February 1st, 2022, from www.
deloitte.com: http://www.deloitte.com/assets/Dcom-Germany/Local%20Assets/
Documents/13_FocusOn/M%20an%20A/2012/M&A_Forum_01_2012.pdr
Spanninger, J. (2011, April 1st). (G. Müller-Stewens, Editor) Retrieved February 1st, 2022, from
www.ma-review.de: https://ma-review.de/hefte/ma-review-02-2011
Timmreck, C., & Bäzner, B. (2012). Mergers & Acquisitions als strategisches Instrument im
Rahmen der Branchenkonsolidierung. In G. Picot (Ed.), Handbuch Mergers & Acquisitions.
Planung - Durchführung - Integration (5th ed., pp. 105–132). Schäffer-Poeschl.
Trunk, T. (2010). Das Insider-Dossier: Die Finance-Bewerbung. Investment Banking, Private
Equity (3rd ed.). squeaker.net.
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Unternehmenszusammenschlüssen (2nd ed.). Springer Gabler.
David and Goliath: Mid-cap and Large-cap
Companies 2

• When exactly do we speak of a medium-sized company and when of a large

company?
• What special features do most medium-sized companies have in common and
what usually characterizes a large company?

These questions are examined in the following subsections and, after a precise
delineation of the two groups of companies, their respective characteristics in the
individual phases of an M&A sales process are analyzed.

2.1 Medium-sized Companies (Mid-caps)

Entrepreneurs—by definition, 99% of them are small- and medium-sized enterprises

(SMEs)—have a key structural advantage over corporate managers: if they want to
be successful, they are not forced to ask capital market experts what they want and
what they are interested in, to enter into a dialog with them and then to fulfill their
wishes. After all, they are the owners, partners, or even shareholders themselves
(Rickes & von Hassell, 2008, p. 20).
The term medium-sized company (mid-cap) covers a broad spectrum of
companies, which will now be narrowed down.

" Definition A common definition of medium-sized enterprises in Germany is

provided by the Center for small- and medium-sized business research in Bonn.
According to this definition, all companies with a workforce of 50 to 499 and annual
sales of between 10 and 50 million euros fall in the medium-sized company segment
(Institut für Mittelstandsforschung Bonn, 2016).

The European Commission has also developed a definition for medium-sized

companies that takes into account the company’s total assets as an alternative
criterion. The EU Commission classifies all companies with 50–249 employees

# The Author(s), under exclusive license to Springer Nature Switzerland AG 2022 15

M. Dreher, D. Ernst, Mergers & Acquisitions, Management for Professionals,
https://doi.org/10.1007/978-3-030-99842-4_2
16 2 David and Goliath: Mid-cap and Large-cap Companies

Table 2.1 Definitions of medium-sized companies

Number of Annual turnover Balance sheet total
Medium-sized companies employees (EURm) (EURm)
Center for SME business 50 to 499 10 to <50 n/a
research in Bonn
European Commission 50 to 249 10 to 50 10 to 43
Adjusted definition 50 to 2000 10 to 500 n/a

and annual sales of 10 to EUR 50 million or total assets of 10 to EUR 43 million as

medium-sized companies (European Commission, 2022).
Concerning the subsequent M&A process analysis, it seems useful to deviate
slightly from the preceding purely quantitative mid-cap definitions. In addition to the
classic mid-caps according to the Center for SME business research or the European
Commission, the following section will also include companies that are actually
located in the lower segment of large companies.
This adjusted definition of medium-sized companies includes all companies that
have between 50 and 2000 employees and annual sales of between 10 and 500 mil-
lion euros (Becker & Ulrich, 2012, p. 21; Furtner, 2011, p. 21; Marks et al., 2012,
pp. 5–6). This extension is justified by the fact that analogous conditions in an M&A
process apply to both segments (classic mid-caps and the lower segment of large
companies). Characteristic for both segments is that the companies are often not
listed on the stock exchange or, if listed, then on rather smaller stock exchange
segments with low liquidity and little free float. They are usually characterized by a
sustainable and long-term strategic orientation, as they are not subject to the short-
term value enhancement pressures of the capital markets. Moreover, they are often
family-run companies or groups of companies (Furtner, 2011, p. 21) (Table 2.1).

2.2 Large Companies (Large-caps)

The maxim for large-cap companies can usually be summed up in one word: more.
It is no coincidence that a supreme discipline of corporations and large companies
is the cost-effective production of large quantities for a large demand for highly
standardized products and services of the same quality—in the consumer goods
market as well as in the capital goods and services market (Rickes & von Hassell,
2008, p. 24).
In addition, large companies often make headlines in newspapers through spec-
tacular takeovers, exciting business expansions, or legal proceedings. The following
section describes which companies can be classified as large enterprises and what
role they play in the German economy.

" Definition Analogous to the definition of medium-sized enterprises, the Center

for small- and medium-sized business research in Bonn defines all enterprises with a
References 17

Table 2.2 Definitions of large companies

Number of Annual turnover Balance sheet total
Medium-sized companies employees (EURm) (EURm)
Center for SME business  500  50 n/a
research in Bonn
European Commission  250 > 50 >43
Adjusted definition > 2000 > 500 n/a

workforce of at least 500 employees and annual sales of at least 50 million euros as
large enterprises (Institut für Mittelstandsforschung Bonn, 2016).

Derived from the previously mentioned definition of the European Commission

large companies are those companies that have a workforce of at least 250 employees
and an annual turnover of more than 50 million euros or a balance sheet total of more
than 43 million euros (European Commission, 2022).
At this point, too, for later M&A process analysis, an adjusted definition for large
companies will be developed for the subsequent M&A process analysis, as was
already the case for mid-caps. The adjusted segment of large companies includes all
companies that have a workforce of over 2000 employees and annual sales of more
than 500 million euros. This extension is justified by the fact that different conditions
apply in an M&A process for companies that fulfill these two criteria than for
companies from the adjusted mid-cap segment. It is characteristic of large companies
that they are often listed on larger stock exchange segments with high liquidity and a
high free float. As a result, they are subject to short-term shareholder value interests.
In most cases, managers with in-depth knowledge of corporate management are at
the helm of large companies. The organizational structure is often complex as well as
independent of individuals. In addition, there are prescribed information paths and a
high degree of formalization. As a rule, large companies have broad access to the
capital market and thus significantly more financing options than smaller companies
(Hackspiel, 2010, p. 132) (Table 2.2).

References
Becker, W., & Ulrich, P. (2012). Aufsichtsräte und Beiräte im Mittelstand. Theorien, Konzeption
und Handlungsempfehlungen. W. Kohlhammer.
European Commission. (2022, January 1st). Retrieved February 1st, 2022, from www.ec.europa.eu:
https://ec.europa.eu/growth/smes/sme-definition_en
Furtner, S. (2011). Management von Unternehmensakquisitionen im Mittelstand. Erfolgsfaktor
Post-Merger-Integration (2nd ed.). LINDE.
18 2 David and Goliath: Mid-cap and Large-cap Companies

Hackspiel, T. (2010). Unternehmensbewertung von KMU - Prozessuale und quantitative

Besonderheiten. In G. Müller-Stewens (Ed.), M&A Review (pp. 131–138). GoingPublic Media.
Institut für Mittelstandsforschung Bonn (Ed.). (2016, January 1st). Retrieved February 1st, 2022,
from www.ifm-bonn.org: https://www.ifm-bonn.org/definitionen-/kmu-definition-des-ifm-
bonn
Marks, K., Slee, R., Blees, C., & Nall, M. (2012). Middle Market M&A: Handbook for investment
banking and business consulting. Wiley & Sons.
Rickes, S., & von Hassell, J. (2008). So gewinnt der Mittelstand! Die Erfolgsmethode kleiner und
mittlerer Unternehmen (und was die großen von ihr lernen können). Gabler.
M&A Sales Process
3

" Definition Depending on which party takes the initiative for an M&A transac-
tion, it is referred to as a sell-side (sale of a company) or a buy-side (purchase of a
company) (Ernst & Häcker, 2011, p. 21).

An M&A sales process is typically divided into the following phases and milestones
(Fig. 3.1):
Phase 1: Preparation phase
• The starting signal: Beauty contest
• Mandate agreement
• Selection of a suitable process
• Comprehensive data procurement and company analysis
• Candidate search and selection
• Documentation
Phase 2: Market approach—point of no return
• Addressing potential buyers
• Phase 3: Examination of financial aspects
• Due diligence
• Company valuation
• Structuring of the transaction
Phase 4: Legal aspects of an M&A sales process
• Contract negotiations
• Binding offer
• Purchase agreement
• Closing

In the following, a structured and thorough analysis of these four phases is

provided. Furthermore, explicit differences, at essential process points (milestones),
between a mid-cap and large-cap M&A sales process are identified and critically
evaluated. The Thai-English saying “same same but different” suitably describes the

# The Author(s), under exclusive license to Springer Nature Switzerland AG 2022 19

M. Dreher, D. Ernst, Mergers & Acquisitions, Management for Professionals,
https://doi.org/10.1007/978-3-030-99842-4_3
20 3 M&A Sales Process

2) Market 3) Examination of
1) Preparation phase 4) Closing phase
approach financial aspects

Fig. 3.1 Four phases of an M&A sales process

comparison between a mid-cap and large-cap company sale. The commonalities can
be found in the superordinate M&A process steps, which mid-caps as well as large-
caps must undergo. The differences of a mid-cap and large-cap transaction are
emerging due to the specific nuances of each single M&A process step. Thus, the
commonalities can be found at the meta-level and the differences appear at the detail
level.

3.1 Phase I: Preparation Phase

3.1.1 From the Sales Idea to the Starting Signal

At this point, the perspective of the selling company (business approach) is to be

briefly taken. This approach appears to make sense since the company willing to sell
must already make some essential preliminary considerations before involving an
investment bank or an M&A boutique in the sales process.

3.1.1.1 Important Questions Prior to the Starting Signal

Company sales are always complex, time-consuming and occasionally strain the
nerves of the parties involved. Mistakes made at an early stage of the sales process
usually prove to be extremely costly in later phases and may be irreparable. It makes
no difference whether a large company wants to sell a subsidiary or a part of a
company to focus on its core business, or whether a medium-sized company initiates
a sales process as part of its succession planning. In both cases, important questions
must be thought through before a sale of the company is initiated.

Question

Is now the right time to sell the company or a part of the company?

If this question is approached from a macroeconomic perspective, economic

highs can be identified as a good time to sell. For listed large companies, the current
stock market trend is a good indicator for determining a suitable date for the sale, as a
strong correlation can be observed between high stock market prices and high
purchase price payments (Exler, 2006, p. 18). In addition to the pure macroeconomic
view, microeconomic analysis also plays a decisive role. If the market is in a boom
phase, but company is not optimally positioned for a sale, then high sales proceeds
cannot be achieved from this constellation. In such a situation, certain strategic
3.1 Phase I: Preparation Phase 21

reorganizations (e.g., strengthening of management levels by experienced managers,

introduction of a new product line, opening of a new branch, and above all,
realization of certain sales and profit figures or margins) should be carried out first
to be able to present the object for sale as attractively as possible to a potential buyer.
In the case of medium-sized companies, which are often family-run, the personal
situation must also be taken into account when evaluating a suitable time for the sale.
Influencing factors, in this case, would be financial, family, and health situations as
well as future planning. Besides, an M&A transaction or a company sale in the case
of medium-sized companies regularly has a one-off character, which is why the
timing of sale should also be selected with particular care with regard to the financing
of retirement provisions.

Question

Does the seller have sufficient knowledge of the special features of an M&A sales
process?

As a rule, large companies can hardly escape the M&A activities of their industry
and markets. They often have extensive experience with mergers and acquisitions
and are very familiar with the typical process steps and various other M&A
parameters. In the lower and middle segments of medium-sized companies, M&A
experience is often limited to a minimum. Family-managed medium-sized
companies only call the topic of M&A onto the agenda when succession planning
arises and have often hardly dealt with company mergers or acquisitions up to this
point. This circumstance often results in an unfavorable start to the sale of the
company, as an unrealistic timetable for carrying out the transaction is usually
hovering in the minds of these entrepreneurs and they are not aware of the complex-
ity of an M&A transaction. Thus, it often happens in medium-sized companies that
the management is severely overwhelmed with a double burden of a corporate
transaction and continuation of the operative day-to-day business. For this reason,
it is important that both medium-sized companies and large corporations have a clear
picture of the scope of this undertaking in the run-up to an M&A project.

Question

Are all the partners or shareholders and the managers pulling in the same direction
about the planned sale?

This is a fundamental question that all parties must be clear about. Large
companies generally have broad organizational structures with several management
levels and separation of the control and performance apparatus. Due to classic
principal–agent conflict, M&A decisions in these companies sometimes involve
decision-making that plays into the managers’ hands thanks to performance-based
pay. However, an M&A sales process is not influenced by this problem. The
situation is different for many medium-sized companies, where company ownership
22 3 M&A Sales Process

and management are often in the same hands. If two shareholders hold a cumulative
stake of more than 50% in the company, if both hold a management position in the
company and if both hold exactly opposing views on the sale of the company, then
the entire M&A process and thus the success of the transaction is on extremely shaky
ground. One of the shareholders could, for example, significantly slow down the sale
process by taking a negative stance or abruptly end the final contract negotiations by
making unrealistic demands. A company sale can also take a similar course if
ownership and management are combined in only one person. It is often not easy
for entrepreneurs to hand over their life’s work to a third party and mentally accept
the idea that they are no longer managing directors or shareholders. It is therefore
clear that transaction outcome depends to a large extent on the harmony amongst
transaction participants and their willingness to sell.

Question

How large should the circle of people privy to an upcoming company sale be?

Confidentiality is one of the top priorities in the M&A business. For this very
reason, the circle of insiders should be determined with great care and at the same
time kept as small as possible. For example, if the circle of people familiar with the
sale of a company is large than necessary in the case of a large listed company, then
information can quickly leak out to the public. This information leak can have a
significant impact on the stock market price of the selling company and thus on the
sale. Another problem that often occurs due to an unintentional, as well as an early
announcement of an M&A sale transaction, is the migration of individual top
performers of the company. If these individuals make a significant contribution to
value creation or possess unique know-how within the company, their departure can
lead to a gradual devaluation of the company’s willingness to sell (Exler, 2006,
p. 33). As a result, the purchase price will decrease and the buying interest of
potential bidders will be reduced. This phenomenon affects both medium-sized
companies and large corporations.

3.1.1.2 Common Sales Concerns

Sales concerns often stand in the way of initiating a company sale and can have
numerous causes. Since medium-sized companies often have less M&A experience
than large companies, this group of companies is particularly sensitive to sales
concerns. Toward the end of 2012, the Royal Bank of Scotland published the
study “Middle Market M&A Outlook 2013” (RBS Citizens Financial Group,
2012, p. 18), which lists, among other things, the most important sales concerns of
medium-sized companies:

• Insufficient proceeds from the sale

• Migration of key personnel of the selling company during or after the corporate
transaction
• Customer perception of quality, service, etc. of the selling company
3.1 Phase I: Preparation Phase 23

• Loss of control and decision-making power

• Merger of two different corporate cultures
• Disruption of operations during the business combination (post-merger
integration)
• Distractions (with regards to day-to-day operations) during the sale process

3.1.1.3 Vendor Due Diligence

In the preparatory phase of a sales process, the seller sometimes commissions a
vendor due diligence (VDD) to provide an independent assessment of the target
company.

" Definition In detail, vendor due diligence is understood as a screening of the

company for sale by external auditors, law firms, and tax consultants. It examines
legal and tax fundamentals as well as the financial position, net assets and results of
operations of the company, assets and earnings situation of the company.

The result of a VDD is a Vendor Due Diligence Report. This VDD report helps to
facilitate structured due diligence in a sales process and is issued to potential buyers
during the due diligence phase (Mohr & Bärtl, 2012, p. 245) (Bühler & Bindl, 2012,
p. 188). A VDD is often carried out during the course of an auction process for
company sales and helps to optimally prepare as well as shorten the due diligence
process (Behringer, 2013, p. 165). In general, the external consultants (auditors or
lawyers) are liable for any errors in the VDD report. However, they endeavor to
minimize their liability about erroneous statements in the VDD report using liability
exclusions.
The costs for VDD are borne by the seller, who can, however, also derive
numerous advantages from the VDD for himself. On one hand, the vendor due
diligence report provides the seller with an objective view of his own company,
enabling him to make a more realistic assessment of the conceivable sales proceeds
(Bühler & Bindl, 2012, p. 189). It also reveals potential weaknesses or deficiencies
in the vendor company, which can consequently be eliminated by the vendor before
the official start of the sales process. As a result, the seller is not confronted with any
surprising negative findings of his company by potential buyers during the contract
negotiations and the buyers are deprived of the argumentation basis for purchase
price reductions. All in all, this significantly strengthens the vendor’s negotiating
position during contract negotiations. On the other hand, the vendor due diligence
report creates a high degree of transparency for potential buyers and helps them to
save costs as part of a shortened due diligence process (Bühler & Bindl, 2012,
p. 188).

3.1.1.4 Universe of Advisors

The seller and potential buyers are not the only parties involved in a sale process.
Because the transfer of ownership of a business is a complicated and often time-
consuming process, the involvement of advisors is strongly recommended. The
number of advisors and the requirement for their specialized knowledge will depend
24 3 M&A Sales Process

on the transaction size and type (Ernst & Häcker, 2011, p. 32). The cost-benefit
planning concerning consultants also represents an important decision variable for
the choice of consultant. In general, the expertise of a consultant can be judged based
on his or her experience. Therefore, before bringing a consultant on board,
companies should ask to be shown relevant M&A consulting references. The most
important advisors in the context of an M&A transaction are:

• Investment banks and M&A boutiques

• Auditors and tax consultants
• Lawyers
• Other advisors

Of course, the supervision of the sales process is left to the seller. He decides on
the potential buyer. In addition, he is always involved in negotiation rounds and in
preparation of the sales documents. Last but not least, the seller bears responsibility
for sensitive areas such as employee issues or disclosure of information (Ernst &
Häcker, 2011, p. 34).

Investment Banks and M&A Boutiques

The most important advisors in a sale process are usually investment banks or M&A
boutiques. Thanks to their in-depth M&A expertise and their national and interna-
tional networks, they are particularly well-positioned to provide an optimal transac-
tion structure. In addition to the information, they receive from advisors involved in
the process, investment banks or M&A boutiques perform a company valuation to
determine a realistic company value range. The preparation of important documents
in the sale process, such as information memorandum or management presentation,
is also part of an investment banks or M&A boutique’s range of tasks. Furthermore,
they assume primary responsibility for the negotiations, as they have a deep insight
into the company’s circumstances and the motives of sellers. Due to a large amount
of important and confidential information, they are in the best position to efficiently
manage the entire M&A process (including negotiations and communication
between the parties) (Ernst & Häcker, 2011, pp. 32–33).
Table 3.1 shows the top ten most successful M&A worldwide Financial Services
Advisors in the first half of 2020 (Mergermarket, 2020a, p. 9):
Table 3.2 shows the top ten most successful M&A worldwide Financial Services
Advisors in the first half of 2020:

Auditors and Tax Advisors

Auditors are required to audit and subsequently certify the annual or consolidated
financial statements. Furthermore, the large auditing firms also offer M&A services
analogous to investment banks and M&A boutiques. They have the expertise to
prepare annual financial statements in accordance with the German Commercial
Code or, in the case of listed companies in Europe, in accordance with IFRS. In the
M&A process, they take on an important support function in carrying out the
so-called financial due diligence and tax due diligence (Ernst & Häcker, 2011, p. 33).
3.1 Phase I: Preparation Phase 25

Table 3.1 Global ranking of M&A financial services advisors in H1 2020 (by cumulative deal
volume)
No. Company name Deal volume (USDm) Number of deals
1 Goldman Sachs & Co. 244.108 103
2 Morgan Stanley 206.145 95
3 JPMorgan 206.145 103
4 Citi 107.251 62
5 Bank of America 102.368 85
6 Rothschild & Co. 93.190 88
7 Credit Suisse 78.869 44
8 Credit Suisse 67.014 51
9 Lazard 65.884 59
10 Evercore 65.302 66

Table 3.2 M&A boutiques in Germany

Company name Website
Clairfield International SA www.clairfield.com
Clearwater International GmbH www.clearwaterinternational.com
DC Advisory (Daiwa Corporate Advisory GmbH) www.dcadvisory.com
IEG (Deutschland) GmbH www.ieg-banking.com
IMAP M&A Consultants AG www.imap.de
MCF Corporate Finance GmbH www.mcfcorpfin.com
Oaklins Angermann AG www.oaklins.com

The four largest auditing firms, which audit the majority of listed audit and advise
the majority of listed corporations worldwide, are referred to as the big four:

• PricewaterhouseCoopers (PwC)
• KPMG
• Deloitte Touche Tohmatsu
• Ernst & Young

Legal Advisors
Lawyers are indispensable concerning a variety of legal issues. The tasks of a law
firm in the context of an M&A transaction range from legal auditing to the develop-
ment and implementation of a legally optimized transaction structure to the provi-
sion and administration of the data room. The lawyers also examine the antitrust
situation of the buyer after the completion of a corporate transaction. The lawyer’s
task in the sales process ends with the preparation of legal documentation of the
process or the signing of the purchase agreement (Ernst & Häcker, 2011, p. 34).
Table 3.3 shows the ten most successful M&A lawyers worldwide in the first half
of 2020 (Mergermarket, 2020b, p. 9):
26 3 M&A Sales Process

Table 3.3 Global ranking of M&A legal advisors in H1 2020 (by cumulative deal volume)
No. Company name Deal volume (USDm) Number of deals
1 Latham & Watkins 132.557 177
2 Freshfields Bruckhaus Deringer 132.083 70
3 Wachtell, Lipton, Rosen & Katz 119.924 35
4 Skadden Arps Slate Meagher & Flom 109.260 73
5 Kirkland & Ellis 98.318 191
6 Allen & Overy 96.887 87
7 White & Case 90.684 141
8 Weil Gotshal & Manges 88.957 74
9 Davis Polk & Wardwell 86.698 63
10 Cleary Gottlieb Steen & Hamilton 81.796 34

Other Advisors
Depending on the target company’s industry, the assumptions and reports of certain
appraisers, engineers, or environmental consultants may be of great value in
assessing the quality of a company’s operations. For example, in the case of a
chemical or pharmaceutical company as a target, environmental due diligence by a
specialized environmental consultant would appear to be extremely useful to identify
potential environmental risks in connection with a planned M&A transaction at an
early stage.

Differences in the Choice of Advisors for Medium-Sized Companies and Large

Enterprises
One of the most significant differences about the M&A process of a medium-sized or
large company is experience. Among other things, it has a strong impact on the
choice of advisor.
Large companies, including multinational companies, often have their own M&A
departments, which, like the company management, deal predominantly with strate-
gic issues. In this context, it is hardly surprising that these departments are directly
attached to the CEO or CFO of large stock corporations (Mohr & Bärtl, 2012,
p. 240). M&A is often seen as a permanent task at large companies, which is why,
thanks to internal M&A departments, a stable circle of M&A experts is created
(Bühler & Bindl, 2012, p. 178). This team has the necessary specialized M&A
knowledge, which makes it possible to better assess, and sales transactions can be
better assessed in advance and more efficiently designed in the course of the process.
Also, repetitive errors are increasingly avoided thanks to the learning curve. In the
case of large companies, however, M&A transactions are by no means one-man
shows of their own M&A department(s). Rather, in the case of sufficiently large and
therefore attractive corporate transactions, well-known investment banks (e.g.,
Goldman Sachs, Morgan Stanley, etc.) are involved, which, thanks to their interna-
tional network and their unique M&A expertise, can ensure an optimal transaction
process and a suitable selection of buyers and sellers. As the M&A process
approaches the due diligence phase, leading accounting and auditing firms (such
3.1 Phase I: Preparation Phase 27

as KPMG, PwC, Ernst & Young, etc.) and law firms are also mandated. The internal
M&A department of the large company significantly facilitates the flow of informa-
tion between all parties thanks to its M&A expertise.
The situation is different concerning medium-sized companies. The lower and
mid-sized segment in particular often does not have its own M&A department
because the size of the company and the available capacities do not permit this.
For many SMEs, it proves unprofitable to bundle M&A expertise within the com-
pany permanently (Müller, 2011, p. 9). Only when a certain level of M&A activity
emanates from a company in terms of transaction frequency and the M&A transac-
tion volume reaches a certain level can the establishment of an in-house M&A
department be seen as the logical next step. Thus, a lack of M&A experience can
regularly be observed in medium-sized companies, which makes the temporary
involvement of experienced external M&A consultants unavoidable during the
course of a planned company sale. However, in medium-sized companies, no
M&A boutiques or investment banks are often entrusted with the transaction prepa-
ration, structuring, and execution at the start of the transaction; instead, the sales
process is initiated with the tax advisor as the sole M&A advisor (Jaques, 2012,
p. 23). For many companies, the tax advisor represents a long-standing contact
person and thus a person of trust, but as a rule, he does not have sound problem-
solving competence in the area of mergers and acquisitions. It is often only during
the sales process that an entrepreneur fully realizes how complex and time-
consuming the sale of a company is. Last but not the least, the immense double
burden of an M&A transaction and continuation of the operative business sooner or
later pushes a medium-sized company manager to his limits. Despite the cost
sensitivity of mid-sized companies, involving the right M&A advisors at the right
time can contribute to significant relief for the entrepreneur and a considerable
optimization of the M&A process. In contrast to large-cap transactions, investment
banks often do not act as M&A advisors in the lower midmarket segment, as they
generally only become active when the transaction volume exceeds a certain level.
What remains are, for example, M&A boutiques that have also positioned them-
selves as competent M&A advisors in this segment.

3.1.1.5 Checklist: The 10 most Important Basic Rules of a Proper Sales

Strategy

Important
Checklist: The 10 most important basic rules of a correct sales strategy
1. The seller should have sufficient knowledge of the framework conditions
of a sales process.
2. All shareholders and managers should be pulling in the same direction
together.

(continued)
28 3 M&A Sales Process

3. Planning the sales process at an early stage is of great importance for the
success of the transaction.
4. The circle of people involved in the upcoming sale of the company should
be kept as small as possible.
5. Preparatory measures should be implemented by the seller before the start
of the transaction.
6. The involvement of experienced M&A advisors in the transaction process
is indispensable.
7. The seller should develop a sales motive that is as credible as possible.
8. The right economic mood should be looked for concerning the start of the
transaction.
9. A seller should not enter the M&A market until all the preparations have
been made.
10. The seller should be prepared for the continuation of the company at all
times.

3.1.2 The Starting Signal: Beauty Contest

From this point until the end of the M&A process analysis, the service approach is
chosen to describe the individual phases of the sale.
At the beginning of the M&A process, there is the so-called beauty contest.

" Definition In a beauty contest, the objective for the investment banks or M&A
boutiques is to present themselves as favorably as possible to the target company in a
presentation and to convince the potential seller of their competencies.

Among experts, this presentation is referred to as a pitch. The pitch presentation

describes the main objective and process of the intended M&A transaction. The goal
is to present the potential customer with a high degree of industry know-how, M&A
expertise, and reputation or to convince and position itself as the right advisor for the
planned M&A project (Ernst & Häcker, 2011, p. 24).

3.1.2.1 Pitch Book

In a beauty contest, investment banks present a so-called pitch book to the potential
client.

" Definition The pitch book is a central marketing tool of the investment bank and
contains a strategic analysis of the company under consideration. The pitch book is
the business card of an investment bank and usually comprises 60–80 pages,
depending on the expected transaction volume. The three main components of a
pitch book are outlined below.
3.1 Phase I: Preparation Phase 29

The first part of the pitch book deals with the strategic, financial, and competitive
situation of the target company. The SWOT analysis (strengths, weaknesses,
opportunities, and threats) is an integral part of this. This analysis provides a clear
picture of the positioning of the company in the market. In addition, a gap analysis is
performed, which is used to identify operational and strategic gaps. Based on the
combination of SWOT and gap analysis, the investment bank or M&A boutique can
provide the target company with value for the execution of the M&A transaction. A
market analysis, which deals with market activity and market development (e.g.,
market volume, growth, market shares, the position of the market in the life cycle,
the intensity of competition, etc.) round off the first part of the pitch book.
The second part of the pitch book examines the target company’s options for
closing existing strategic and operational gaps. If a company acquisition or sale
represents a viable option for eliminating the gaps, potential candidates are identified
and ranked according to their strategic fit. The list of potential candidates is referred
to in the jargon as the long list.
The final section of the pitch book provides recommendations on the appropriate
strategy for the target company. The advantages and disadvantages of each possible
course of action are analyzed based on the current situation and future developments.
Finally, the steps required in the process are listed and discussed. In the third section,
the investment bank or M&A boutique presents the potential client with a company
value range, which provides an initial indication of the sale price that can be realized
in the M&A process. In addition, the M&A advisor discloses its compensation plan
to the target company.
The most important challenge of a beauty contest or pitch is to maintain discre-
tion. Even the rumor of a possible change in ownership can have a detrimental effect
on the target company’s business (Ernst & Häcker, 2011, pp. 23–24).

3.1.2.2 Differences in a Beauty Contest for Medium-sized Companies

and Large Companies
In essence, a beauty contest of a mid-cap or large-cap is carried out in a similar
fashion and the pitch book includes very similar points.
In general, the pitch book for mid-caps is comprised of slightly fewer pages
compared to large-caps. This is due to the fact that access to relevant company
information concerning mid-caps is quite difficult and limited. Many mid-caps are
subject to reduced accounting and publicity rules compared to large-caps due to their
company size and legal form. Consequently, the preparation of a SWOT analysis,
gap analysis, and company valuation are significantly hampered.
Especially in the low range segment of medium-sized companies the beauty
contest is not the standard way for an M&A advisor to be mandated. In such
cases, the M&A advisor is often directly mandated thanks to its national or interna-
tional network. Hence, strong contacts are a vital asset regarding M&A business and
can help to substitute a pitch presentation.
30 3 M&A Sales Process

3.1.2.3 Checklist: Beauty Contest

Important
Checklist: Beauty Contest
• Through a pitch presentation, an investment bank or M&A boutique should
competently demonstrate its relevant industry know-how and its M&A
expertise.
• The goal should be to position themselves as the right advisor for the M&A
project.
• The pitch book is the business card of an investment bank and usually
consists of three parts:
(a) Part 1: SWOT, gap, and market analysis
(b) Part 2: Measures to close strategic and operational gaps and presenta-
tion of the long list
(c) Part 3: Advantages and disadvantages of several alternative courses of
action of the target company, indicative company valuation, and com-
pensation proposal
• The most important challenge of a beauty contest is maintaining discretion.

3.1.3 Mandate Agreement

If an investment bank or M&A boutique has been able to place itself in the Beauty
Contest or directly through its network for an M&A sale mandate, then a mandate
agreement is subsequently drawn up between the target company and the M&A
advisor.

" Definition The mandate agreement is a legal document that defines the relations
between the investment bank or M&A boutique and the client. It regulates in detail
the transaction objectives of the seller and its expectations toward the advisor.

As a rule, an investment bank or M&A boutique should never act without a

signed mandate agreement, because on one hand, it has no legal legitimation to act
due to confidential information (liability risks) and on the other hand, it has no claim
to a fee. The signing of the mandate agreement also shows that the client is really
committed and stands behind the intended transaction.

3.1.3.1 Typical Contents of a Mandate Agreement

The mandate agreement between an investment bank and a seller contains the
following core elements (Ernst & Häcker, 2011, pp. 36–37):
3.1 Phase I: Preparation Phase 31

1. Subject matter and objective of the agreement

(a) The Principal intends to (partially) sell Company A (hereinafter also referred
to as Target Company or Principal). The Target Company also consists of
direct or indirect subsidiaries and participations.
(b) The Principal instructs the investment bank or M&A Boutique to advise it
about pending transaction negotiations.

2. Obligations and services of the investment bank

The investment bank, in close coordination with the client, should, among other
things, provide the following advisory services:
(a) Analysis and evaluation of the target company, its business activity, and asset
situation
(b) Preparation of a business valuation
(c) Support in preparing the documentation (information memorandum, teaser,
management presentation, etc.)
(d) Preparation of a list of potential buyers as well as initiation and management of
negotiations with decision-makers of these interested parties in close coopera-
tion with the client.
(e) Advising on conclusion of letters of intent and exclusivity agreements
(f) Preparation and execution of due diligence
(g) Advising the client on the transaction structure
(h) Advice regarding contract negotiations and the purchase agreement

3. Remuneration
(a) Remuneration independent of performance: The so-called flat fee or retainer
is paid monthly. The investment bank or M&A boutique charges a fixed
monthly retainer fee to compensate for costs incurred (e.g., for research or
research or telecommunications).
(b) Success-based compensation: The success fee is a percentage of the subse-
quently achieved transaction value. There are several ways to structure the
success fee. In the interest of maximizing profit, a seller should always make
sure that the investment bank or M&A boutique receives incentives. This is
done, among a success fee that grows proportionally with the transaction
value. For a transaction value of 100 million, a basic success fee could be, for
example, approx. 1% of the transaction value.

4. Services of the client

(a) During the validity of this agreement, the investment bank or M&A boutique
is exclusively entrusted with the subject matter and objective of this
agreement.
(b) At the request of the investment bank or M&A boutique, the client must
provide it with all information and documents relevant to the transaction.
(c) The client is only authorized to enter into discussions with a buyer and its
direct or indirect shareholders with the prior consent of the investment bank
or M&A boutique.
32 3 M&A Sales Process

(d) The client agrees that the investment bank or M&A boutique uses publicly
available information without prior review for completeness or accuracy.
5. Liability
The investment bank or M&A boutique is only liable for damages that are based
on intent or gross negligence.
6. Confidentiality
(a) The investment bank or M&A boutique undertakes to treat all information
received from the client as strictly confidential. This provision does not apply
to publicly available information regarding the target company.
(b) The investment bank or M&A boutique requires an expressed consent from
the principal for the publication of this confidential information or the
disclosure of this information to third parties.
7. Termination
(a) The contract may be terminated by either party at any time. The termination
must be in writing to be effective.
(b) Should the client terminate the mandate agreement with the investment bank
or M&A boutique, the investment bank or M&A boutique shall nevertheless
be entitled to a success fee for the next two years if the client concludes the
transaction with a long-list candidate and/or approached company identified
by the investment bank or M&A boutique.
8. Place of Jurisdiction
(a) The contract is exclusively subject to the laws of the Federal Republic of
Germany.
(b) The place of arbitration shall be Frankfurt am Main. The language of the
arbitration proceedings shall be English.
9. Miscellaneous
(a) The contract contains all agreements between the client and the investment
bank or M&A boutique regarding this matter. There are no written or oral
collateral agreements.
(b) If any individual provision of the contract be or become invalid, the validity
of the remaining provisions of the contract shall remain unaffected. The
ineffective clause shall be replaced by the permissible clause which most
closely reflects the common economic sense.

3.1.3.2 Checklist: Mandate Agreement

Important
Checklist: Mandate Agreement
• In the context of a sale transaction, the mandate agreement regulates the
rights and obligations of the M&A advisor and the seller.
• Typical contents of a mandate agreement are:

(continued)
3.1 Phase I: Preparation Phase 33

1. Subject matter and objective of the agreement

2. Obligations and services of the investment bank
3. Remuneration
4. Services of the client
5. Liability
6. Confidentiality
7. Termination
8. Jurisdiction
9. Miscellaneous

3.1.4 Selection of a Suitable M&A Procedure

There is a conflict of objectives regarding the selection of a suitable procedure for the
sales transaction. There is no single M&A procedure, which simultaneously allows
the seller to accomplish a maximization of the sales price and the highest degree of
confidentiality (Mohr & Bärtl, 2012, p. 243). In general, a broad field of bidders in
the sales process increases the competitive pressure among potential buyers, which
has a direct positive effect on the level of the attainable sales price. At the same time,
however, an increasing number of potential buyers also increases the transaction
effort on the part of the seller and increases the risk that the intention to sell could
become public at an early stage. A suitable transaction procedure must therefore be
selected that best suits the particular characteristics of the company for sale. Thanks
to its experience, an investment bank or M&A boutique can provide the seller with
targeted advice on the choice of a suitable procedure.
The seller has a choice of several procedures for approaching potential buyers
when selling a company (Fig. 3.2).

3.1.4.1 Exclusive Procedure

" Definition An exclusive procedure is a one-to-one negotiation with a potential

buyer.

A special feature of the exclusive procedure is that the seller has already been able to
identify the optimal buyer in advance of the sales transaction. This potential buyer
has the perfect fit from the seller’s point of view (Marks et al., 2012, p. 103).
Subsequently, exclusive negotiations are to be held with this acquirer in the planned
M&A process. The seller company or its M&A advisor establishes contact with the
buyer and provides it with initial relevant information about the target company. If
the potential acquirer agrees to an exclusive process, the next step is initial negotia-
tion talks, which are used to clarify key transaction factors and the transaction
structure. If, after these initial rounds of talks, both the seller and the buyer are still
34 3 M&A Sales Process

M&A sales procedures

Exclusive procedure Parallel procedure Auction

Controlled Full
competitive public

Fig. 3.2 M&A sales procedures

interested in an exclusive procedure, due diligence of the target company can be

initiated promptly and negotiations on the purchase agreement can be conducted.
The exclusive procedure offers the seller some decisive advantages. In addition to
the seller and his M&A advisor, only one other potential buyer is privy to the
planned sale, which guarantees a high degree of confidentiality. Besides, the
tailor-made transaction structure allows for quick completion of the sale.
However, the one-on-one process also brings some disadvantages for the seller.
The most obvious disadvantage is the lack of buyer competition. As a result, the
seller cannot make a comparison with other purchase price offers and cannot use
buyer competition to maximize the selling price. Both factors lead to a weak
negotiating position of the seller and regularly result in suboptimal sales proceeds.

3.1.4.2 Parallel Procedure

" Definition A parallel procedure is understood to mean simultaneous negotiations

with a narrowly selected group of potential buyers.

During the course of the parallel procedure, the investment bank or M&A boutique is
tasked with identifying a selected number of suitable potential buyers and, after
consultation with the seller, contact them separately. During the sales process, this
selection is reduced to two or three potential buyers with whom purchase agreement
negotiations are finally entered.
In this way, a higher level of competition can be established than in the exclusive
procedure, and at the same time a purchase price offer comparison can be carried out
at the same time. Besides, a certain degree of confidentiality is also ensured in the
parallel procedure.
The disadvantages of this procedure are the higher publicity of internal company
data and a frequently lower selling price than in an auction.
3.1 Phase I: Preparation Phase 35

3.1.4.3 Auction
Even in Roman times, the primary objective of an auction was to determine the
maximum achievable price for a given good based on the underlying bidding
competition (Rochat & Korp, 2010, p. 270).
Today, an identical ulterior motive leads decision-makers in corporate sales to opt
for an auction when choosing a procedure. The two most common M&A auction
types are:
• Controlled competitive auction
• Full public auction

Controlled Competitive Auction

" Definition The controlled competitive auction (also called private auction) is a
carefully supervised bidding process that gives the seller a high degree of control
over the terms of the transaction (e.g., timing, reserve price, etc.).

On the seller side, the targeted deadline pressure and focus guarantee the mainte-
nance of dynamics and tension in the auction process (Rochat & Korp, 2010, p. 274).
A select group of potential buyers is invited to the auction. An investment bank is
regularly entrusted with the preparation and execution of the auction. The aim of the
expanded group of bidders is to build up greater competitive pressure in order to
achieve a higher transaction price than in the two transaction procedures described
above.
The advantage of this procedure, in addition to the greater transparency of the
bids, is the possibility of achieving a more attractive selling price as a result of the
bidding competition than in an exclusive or parallel procedure.
A significant disadvantage of the private auction is that the market learns of the
seller’s intention to sell. In addition, the potential for information leakage is much
higher with this approach than with the other two (Ernst & Häcker, 2011, p. 25).

Full Public Auction

" Definition A public auction is a public announcement of intent to sell and

conduct a controlled bidding process.

The public auction is initiated with a public announcement about the intention to sell.
As a rule, the well-known investment banks position themselves as advisors to the
seller. The auction takes place in a highly competitive environment among a large
number of bidders, thus enabling a high sales price to be achieved.
However, since there is no guarantee of this, the seller should weigh this theoreti-
cal advantage against the disadvantages of this transaction procedure. The
disadvantages of the public auction become more significant the more complicated
the seller’s corporate situation is. In particular, the following disadvantages are
regularly observed (Ernst & Häcker, 2011, p. 26):
36 3 M&A Sales Process

• The business relations of the seller could be damaged by the public announce-
ment of the sales process.
• As a result of failed sales processes, the value of the company may be unfavorably
influenced.

In addition, the seller should keep in mind that the termination of the process is
less controllable. Especially if shareholders are concerned after a failed sales pro-
cess, this often results in a wave of selling of the shares of the target company.
Consequently, the share price falls and the door is opened for a possible hostile
takeover.

3.1.4.4 Differences in Process Selection for Medium-sized Companies

and Large Enterprises
When choosing a procedure, both medium-sized and large companies can generally
choose from the full range of sales procedures.
In the case of larger corporate transactions, an auction can make perfect sense,
since it allows the highest possible sales proceeds to be achieved on one hand, and on
the other hand, due to the attractiveness of many large companies, a large group of
bidders regularly wants to enter the auction. The bidding process, on the other hand,
does not appear to be very appropriate for smaller SMEs, as the desired level of
confidentiality cannot be maintained (Preisser & Cavaillès, 2011, p. 13).
In lower and mid-market segments, a company transaction is often carried out by
using a parallel procedure. This procedure allows SMEs to maintain the desired level
of confidentiality about the planned sale and at the same time to achieve an attractive
sales price.

3.1.4.5 Checklist: Process Selection

Important
Checklist: Process selection
Exclusive procedure
• Purchaser group: one potential purchaser
• Level of confidentiality: high
• Buyer competition: not available
• Advantages: high level of confidentiality; perfect fit; quick closing can
be realized
• Disadvantages: no bidder competition; weaker negotiating position of
the seller; lower sales price
Parallel procedure
• Group of buyers: selected number
• Level of confidentiality: medium
• Buyer competition: medium

(continued)
3.1 Phase I: Preparation Phase 37

• Advantages: Selection of the most suitable bidder; confidentiality

largely maintained; bid comparison possible from seller’s point of view
• Disadvantages: higher publicity of internal company data; lower sales
price than in an auction
Auction
• Group of buyers: broader field
• Level of confidentiality: low
• Buyer competition: high
• Advantages: broad buyer universe; greatest possible price transparency
• Disadvantages: Information about willingness to sell reaches high pub-
licity of internal data; image problems in case of abortion or failure of
the transaction

In the following explanations of the M&A sales process, the parallel procedure is
assumed to be the chosen transaction procedure.

3.1.5 Comprehensive Data Collection and Company Analysis

The advising investment bank or M&A boutique requires certain data from the seller
to prepare important sales documents, such as the information memorandum. Upon
receipt, the M&A advisor sifts through the data packages, structures the documents
and relevant information, and conducts a comprehensive business analysis. These
steps help to ensure that the sale project can be pushed ahead.

3.1.5.1 Obtaining Comprehensive Data

Depending on the size and legal form of the company for sale, the investment bank
or M&A boutique could already collect a certain volume of relevant company
information during the beauty contest, evaluate it, and include it in the pitch book.
Further company data that is not publicly available should be requested at this point.
If the sales mandate was awarded directly to the M&A advisor, there is a need to
catch up at this point and the seller should be asked to forward comprehensive
relevant data. In general, the investment bank or M&A boutique should have the
following information about the seller’s company in order to prepare a meaningful
sales exposé and structure the transaction:

• The last 3 to 5 annual financial statements

• Planning data for the coming fiscal years (e.g., balance sheet, income statement,
and cash flow statement)
• Organizational structure (organization chart)
• Individual business units (e.g., share of sales, know-how, value added, cost
structure, etc.)
• Shareholder or ownership structure
38 3 M&A Sales Process

• Management (e.g., curricula vitae, photographs, etc.)

• Employee structure
• Customer and supplier structure
• Planning of strategic company goals, product launches, geographic
expansion, etc.
• Marketing and advertising information (e.g., company brochures, product
catalogs, press materials, usable photographs, etc.)
• Manufacturing and production information (e.g., locations, technical facilities,
production processes used, etc.)
• Internal market studies (e.g., market volume, market development, market shares,
intensity of competition, etc.)
• Information on leasing and factoring activity

In addition to electronically transmitted data packets, arranging interviews with

senior management or owners of the seller company can be another tool for
obtaining data. Additional information that can be obtained in this way includes
(Marks et al., 2012, pp. 93–94):

• Current developments and trends in the market

• Evaluation of strengths and weaknesses on the part of management
• Motivation and know-how of employees
• Existing or impending legal disputes
• Disagreements among owners or managers
• Previous failed attempts to sell the company

3.1.5.2 Company Analysis

Analogous to data procurement, a comprehensive company analysis (SWOT, gap,
market analysis, etc.) may have already been conducted as part of the beauty contest.
Thanks to the mandate, the investment bank or M&A boutique can include
non-public information in the company analysis due to a higher level of confidenti-
ality. Before the sales exposé is prepared, a detailed investigation of the target
company based on the following questions appears to be useful:

• What are the company’s core competencies and weaknesses?

• What does the value chain look like?
• What untapped potential is there in the target company?
• What opportunities and risks exist in the market?
• Does the current capital structure make sense?
• What is the cost structure (e.g., fixed costs and variable costs)?
• Is the corporate planning (e.g., targeted sales growth, planned cost reduction, etc.)
realistic?
• What are the unique selling propositions (USPs) of the company compared to its
competitors?
• What (liability) risks exist that a potential buyer could use to reduce the purchase
price during the purchase agreement negotiations?
3.1 Phase I: Preparation Phase 39

• Is there a cluster risk with regard to customers or suppliers (e.g., few customers
accounting for a high share of sales)?
• Are the year-end data to be adjusted for special effects (e.g., extraordinary
expenses)?

3.1.5.3 Differences in Data Acquisition and Business Analysis

for Medium-sized Companies and Large Companies
Large companies regularly have greater employee resources and their own M&A
departments. Both factors help to ensure that the necessary flow of information
between the investment bank and the seller is optimal. Last but not the least, due to a
higher disclosure requirement for many large companies, M&A advisors can collect
and structure publicly available relevant company information (e.g., quarterly
reports, consolidated financial statements, analyst reports, etc.) about the seller at
an early stage. This enables a well-founded company analysis to be carried out at an
early stage and facilitates the procurement of data during the sales process.
The picture is often different for medium-sized companies. Smaller medium-
sized companies usually have fewer staff resources and no M&A department of their
own. Apart from the managing directors, only a few other employees are involved in
the sale project. If an M&A consultant approaches such a company willing to sell
with a request to transfer a huge amount of data, the company may be overwhelmed.
The employees and managing partners of a medium-sized target company must, in
addition to their involvement in the M&A project, attend to their daily operational
business. Thus, the flow of information from the target company to the M&A advisor
can be significantly impeded due to the frequently encountered resource bottleneck.
This problem can be counteracted with checklists that show the seller exactly which
necessary information must be provided up to which milestone in the sales process.
Furthermore, the lower disclosure requirements associated with the choice of legal
form for many medium-sized companies pose certain problems for M&A advisors in
the context of the necessary company analysis for a beauty contest. The publicly
available company information is often severely limited, which requires the invest-
ment banks or M&A boutiques to make a certain amount of generalist statements
concerning the pitch presentation in terms of company illumination (SWOT and gap
analysis). Also, a low level of planning can often be observed in the lower
midmarket segment. Thus, budgeted balance sheets, financial and budget plans, as
well as a cash flow statement for the coming year, are often not available (Exler,
2006, p. 20). All in all, this makes it more difficult to conduct a comprehensive
company analysis as early as the beauty contest and increases the M&A advisor’s
need for information in the run-up to the preparation of the sales documents.
40 3 M&A Sales Process

3.1.5.4 Checklists: Data Procurement, Company Analysis

Important
Checklist: Data procurement
• Checklists make it easier for the seller to cope with the data transfer.
• The M&A advisor should not request all information from the target
company at once, but when he needs it (but with a certain lead time).
• In addition to electronic data submission, interviews can also be used to
gather information in a meaningful way.
• Typical information requests include:
• The last 3 to 5 financial statements
• Planning data for the coming fiscal years
• Organizational, ownership, employee, customer, and supplier structure
• Marketing and advertising information
• internal market studies

Important
Checklist: Company analysis

• What are the company’s core competencies and weaknesses?

• What does the value chain look like?
• What unused potential is there in the target company?
• What are the opportunities and risks in the market?
• Does the current capital structure make sense?
• How is the cost structure set up?
• Is the corporate planning realistic?
• What are the unique selling points of the company?
• What (liability) risks exist?
• Is there a cluster risk concerning customers or suppliers?
• Can the annual financial statement data be adjusted for neutral expense
items?

3.1.6 Buyer Universe and Identification of Suitable Buyers

Anyone considering a business sale should have a clear understanding of the

different types of buyers. Not every buyer is suitable for a particular sales transaction
to the same extent. Rather, the different buyer groups pursue divergent goals and are
endowed with certain special characteristics.
3.1 Phase I: Preparation Phase 41

Knowing the different types of buyers is an essential basic step of a sales

transaction. The next and far more important step is to identify the most suitable
buyers in each group for the specific sales project. Possible buyers identified in this
way are recorded on a so-called long list. Depending on the specifics of the company
and the preferences of the decision-makers, a different long list can be generated for
(virtually) every company sale.
In the following, both the buyer universe and the procedure for buyer identifica-
tion in the context of a company sale are examined in detail.

3.1.6.1 Buyer Universe

Three types of investors can be considered as potential buyers:

• A management team inside (MBO) or outside (MBI) the target company

• Financial investors
• Strategic investors

Management Team
Depending on whether the buyer is a management team or a single manager from
inside or outside the target company, it is referred to as a management buy-out or
management buy-in.

Management Buy-out

" Definition If the potential buyer is the previous (non-shareholding or minority-

owned) management or a co-director of the target company, this is referred to as a
management buy-out.

In the case of unregulated company succession, MBO transactions play an important

role, especially in owner-managed small and medium-sized companies. In this way,
a former owner or founder can place his life’s work in trusted hands. In addition,
banks are generally very open to MBO transactions. A major reason for this is the
deep familiarity of the existing management with the target company and is
associated with a smooth continuation of the business.
Based on the frequently limited equity resources of the management team willing
to buy, partners have to be brought into the MBO boat for successful acquisition
financing. These partners are financial investors who act as an alternative source of
financing and, in return, also become new owners of the target company alongside
the management team willing to buy.
In the context of an MBO transaction, lower purchase prices are often paid due to
the poorer debt service capability of the acquiring management and the unchanged
going concern (without exploiting synergy potential) (Ernst & Häcker, 2011, p. 28).
The former owner must therefore accept lower sales proceeds in return for the
certainty of having transferred his company into good hands.
In individual MBO cases where no debt financing is offered by banks, the
financing can be represented by a vendor loan or, depending on the results, by an
42 3 M&A Sales Process

earn-out model. An earn-out model is mainly used if the seller plays a significant role
in the success of the company at the time of the sale. He should remain in the
company for a certain period of time in order to actively participate as a (co-)
manager in the transition phase and to secure the valuation-relevant operating result.
The existing corporate structures of the target should initially remain essentially
unchanged for the purpose of comparability with the results of the previous financial
years.
In conclusion, a management buy-out brings some advantages and disadvantages
for the management team. The advantages are the future financial independence and
the lower risk than in the case of a new company start-up. A clear disadvantage
presents itself in the form of the relatively high indebtedness of the management
team, which creates a conceivably high pressure. Abnormally high cash flows have
to be generated in the company in the shortest possible time to repay the acquisition
financing, which severely restricts the volume for new entrepreneurial investments
(Ernst & Häcker, 2011, p. 28).

Management Buy-in

" Definition A management buy-in is executed when the company is sold to an

external management team.

The trigger for such a transaction is usually the perception of a financial investor that
the current management level of the target company is not contributing optimally to
the company’s development and that there is hence great potential lying dormant in
the company. The financial investor acquires the target company together with a
management team from outside the company and would like, for example, to
position the company more competitively by changing the corporate strategy and
thus increasing the value of the company.
The purchase prices paid in the context of an MBI transaction are rather low,
similar to an MBO transaction (Ernst & Häcker, 2011, p. 28).
In the past, numerous MBIs of various sizes have failed. The main reasons for this
were the incompatibility of the new management with the target company, the lack
of a second management level in the target company, the new management’s lack of
industry knowledge or overly ambitious acquisition financing, which left no room
for error or weak phases with regards to the company’s development (Ernst &
Häcker, 2011, p. 28).

Typical Criteria for MBOs and MBIs

For a successful completion of an MBO or MBI project, both the company and the
management must meet the criteria in Table 3.4.
In large buy-out transactions, a mixture of MBO and MBI can often be observed.
This means that the existing management is supported by an external management.
Side note: Another form of buy-out is the so-called leveraged buy-out (LBO). An LBO exists
if the buy-out is financed with a high proportion of debt capital. The term leveraged buy-out
is mainly used for company acquisitions (or partial acquisitions) that exceed a debt financing
3.1 Phase I: Preparation Phase 43

ratio of 50%. The idea of the LBO is basically to exploit the leverage effect of debt financing.
The leverage effect makes it possible, for example, to carry out the acquisition financing of
major transactions with a relatively low equity investment (Janeba-Hirtl, 2005, p. 20). At the
same time, a disproportionate increase in the return on equity in the target company can be
expected as long as the return on total capital is higher than the interest on debt (leverage
effect). The types of buyers that regularly enter into LBO transactions are financial investors.

Financial Investors

" Definition Financial investors are investors who pursue purely financial
objectives with their investment.

They include, for example, private equity houses (e.g., Advent International or EQT
Partners) or hedge funds (e.g., J.P. Morgan Asset Management or Bridgewater
Associates). The investment perspective of financial investors differs significantly
from that of a management team or strategic investor. Financial investors place a
special focus on the expected return and the period in which a certain profit is to be
realized. As a rule, financial investors hold their stake in a company for a limited
period of 4–8 years and, in contrast to strategic investors, cannot realize any synergy
effects with the purchase. However, during the holding period, they can implement a
so-called buy-and-build strategy to increase the enterprise value of the acquired
company (portfolio company). This is understood to mean that the acquisition of
further compatible and, if possible, synergistic companies, which are subsequently
integrated in the portfolio company. After a certain holding period duration, the
investment in the company is then to be sold to a third party, if possible, at a profit,
and therefore meeting certain targeted returns. The end of the holding period or the
point in time at which the portfolio company is sold is referred to as exit.
The financial investor can choose between an open and a silent investment. In the
case of a silent partnership, the financial investor becomes a silent partner in the
target company and receives a regular dividend corresponding to the contribution
made. In the case of an open investment, the financial investor acquires the shares in

Table 3.4 Typical criteria for MBOs and MBIs (Ernst & Häcker, 2011, p. 28)
Requirements for the target company Requirements for the management team
• Low investment requirements • High level of industry knowledge and
experience
• Undervalued assets • Profound management experience
• Sufficient debt capacity • A certain degree of willingness to take risks
• Independence from current • Adequate financial resources
management
• Established market position • Good contacts to financial investors
• High barriers to market entry • Well-thought-out acquisition plan
• Low need for research and
development
• Stable earnings and cash flows
44 3 M&A Sales Process

Table 3.5 Advantages and disadvantages of a silent partnership (Ernst & Häcker, 2011, p. 29)
Advantages of a silent partnership Disadvantages of a silent partnership
• Company retains its independence and • High return on investment (ROI) required
freedom of action
• Higher equity ratio for financing growth • Open investments offer a higher return
and investments potential at exit time
• No collateral required usually

Table 3.6 Advantages and disadvantages of an open-ended investment from the perspective of the
target company (Ernst & Häcker, 2011, p. 30)
Advantages of open participation Disadvantages of open participation
• Company retains its independence • Acquisition price depends on company value
and freedom of action (company valuation is required)
• Higher equity ratio for financing • Lower value and price for minority interests
growth and investments (no strategic premium)
• No or only low interim interest or • Financial investors receive a higher share value at
dividends exit time
• Financial investor has a say in important business
decisions

the target company, after a certain holding period, attempts to generate a certain
return on the capital invested, through the sale of the company or an IPO. A
combination of both options is also possible.
The silent partnership enables the company to maintain its independence and
freedom of action with regard to entrepreneurial decisions. The improved equity
ratio, thanks to the financial investor’s contribution, also enables the target company
to realize further growth. However, many financial investors are somewhat reluctant
to invest in silent partnerships. Open investments are often favored, since a signifi-
cantly higher potential return can be realized in an event of a positive development at
the time of exit (Ernst & Häcker, 2011, p. 29) (Table 3.5).
In the context of an open investment, financial investors are exposed to greater
potential losses. These can occur, for example, due to a lack of participation in the
management of the company. It is therefore advisable for financial investors to
participate in important business decisions or to make them independent. In addition,
the target company must offer attractive exit opportunities in order to meet the high
return expectations of investors (Ernst & Häcker, 2011, p. 30) (Table 3.6).

Strategic Investors
Strategic investors represent the third type of buyer. They are interested in expansion
(e.g., extension of distribution network, increase in market share, elimination of
competitors, etc.) and meaningful diversification of their business activities.

" Definition Strategic investors do not focus on achieving purely short-term finan-
cial gains, but rather on realizing potential synergies and a long-term investment
3.1 Phase I: Preparation Phase 45

horizon. For this reason, strategic investors are generally prepared to pay a higher
purchase price than the other two types of buyers.

The prime example of a strategic investor is a direct competitor of the target

company, who has a larger company size and sufficient surplus liquidity to finance
the acquisition. His buying interest may be motivated, for example, by eliminating
competitors, increasing his own market power, or realizing cost synergies. As a
direct competitor has extensive industry know-how, it can often carry out the due
diligence that follows in the course of the transaction much more effectively and
efficiently than the other types of investors. When selling one’s own company to a
competitor, great care must be taken on the part of the seller with regard to passing
on information. A competitor could sneak into the sales process as a potential buyer
in order to eavesdrop on the target company and use the information for its own
purposes. Both could result in considerable damage to the target company. A certain
degree of secrecy and a high degree of discretion must be ensured (Table 3.7).

3.1.6.2 Identification of Suitable Buyers

A sales project stands or falls with the selection of the most suitable buyers. If the list
of potential buyers consists of the wrong target group or if important suitable buyers
have been overlooked, it is highly likely that a lower sales price will be realized and,
in the worst-case scenario, even the entire sale of the company will fail at a later stage
of the M&A process (Sattler & Seng, 2010, p. 65).

From Long List to Short List

The identification of suitable buyers takes place either in the run-up to the beauty
contest or, in case of a direct mandate, at this point in the sales process. The
investment banks or M&A boutiques suggest potential buyers to the seller, who
are listed in a so-called long list.

" Definition A long list is a rough selection of as many suitable buyers as possible.

Depending on the specifics of the company and the preferences of the decision-
makers, a different long list can be generated for (almost) every company sale.
Before the creation of the long list can be carried out, one thing must be kept
in mind: Know the target market before developing the marketing book. After the

Table 3.7 Advantages and disadvantages of selling the company to a strategic investor (Ernst &
Häcker, 2011, p. 31)
Disadvantages of selling to a strategic
Advantages of selling to a strategic investor investor
• Experienced company succession by industry • Lengthy and complicated negotiations
experts
• Solid foundation for future business • Risk of spying by competitors
development
• Higher sales proceeds possible
46 3 M&A Sales Process

M&A consultant has developed a sound understanding of the seller’s business

activities, corporate strategy, and industry, the subsequent screening process must
address these questions, among others (Marks et al., 2012, p. 94):

• Who are the most likely buyers of the target company?

• Are there related industries or sectors whose companies have a clear strategic fit
for the seller?
• Are there companies that have already been active buyers in the target industry of
the target company?
• Which financial investors have made investments in the target company in the
past (last 5–10 years) acquired stakes in the target industry or expressed a clear
interest in buying?
• Has the seller already received unsolicited purchase offers in the past?

Typical sources of information as part of a buyer screening process to create a

long list include:

• Websites of industry associations and trade shows

• Specialized databases
• Analyst reports and market studies
• Knowledge of the target company’s management level about potential buyers

Frequently encountered filter criteria for potential buyer companies that make it
into the long list are (Wirtz, 2012, p. 192):

• Clear relation to the target company’s field of activity (strategic fit)

• Financial data (e.g., sales, EBITDA, growth potential, debt/equity ratio, etc.)
• Is sufficient financial strength available to handle acquisition financing?
• Ownership structure and degree of control
• Market position of the potential buyer
• Number and profile of employees
• Product and customer portfolio
• Production sites and distribution network
• Potential synergy effects

Concerning the creation of a qualified long list, the search for potential buyers
should be as imaginative and open as possible. It must include not only companies
with similar business activities to those of the target company, but it is also necessary
to look outside the box for buyer companies with an identical value chain and which
could therefore see synergy potential in a takeover of the company for sale.
A long list is usually compiled in Microsoft Excel and contains the following
information:

1. Prioritization of buyers (ranking)

2. Name of the buyer company (incl. legal form)
3. Homepage
3.1 Phase I: Preparation Phase 47

4.
Financial data (e.g., sales, EBITDA, gearing)
5.
Number of employees
6.
Country (where is the company located?)
7.
A concise description of the buyer company
8.
Shareholders or shareholder structure
9.
Relevant contact person, e.g., managing partner, CEO, CFO, or Head of M&A
(incl. full name and position)
10. Contact details (e-mail and direct extension number of the contact person)

After a qualified long list has been created, it is necessary to have a consultation
with the vendor. In the course of this exchange, the long list is to be reduced to a
so-called short list by eliminating potential buyers who are not to be included in the
shortlist on the basis of certain requirements or exclusion criteria.

" Definition A shortlist is a listing of a selected number of the most suitable buyers
to be approached for the next M&A phase. Companies on the short list will learn
about the target company’s intention to sell in the course of the subsequent market
approach and are to be contacted as potential buyers.

The following, frequently encountered filter criteria should be taken into account
when creating a short list (Ernst & Häcker, 2011, p. 30):

• Maximum and minimum turnover

• Geographical location
• Business experience
• Market share
• Reputation
• Corporate culture
• Wishes of the target company (e.g., exclusion of certain direct competitors)
• Particular strengths, such as research & development, sales or production
• Listed on the stock exchange or privately managed

As a rule, the seller usually establishes its buyer focus early on and concentrates
on either financial or strategic investors. However, in order to maintain competition,
one or two additional buyers from other investor groups are contacted with regard to
the market approach. Should all potential buyers terminate sales negotiations at an
advanced stage of the sales process, the short list will be extended and previously
eliminated potential buyer companies from the long list will be contacted.

Differences in the Identification of Suitable Buyers for Medium-sized

Companies and Large Corporations
In essence, the filter criteria listed above for creating a long list and subsequent
shortlist apply to both the sale of a medium-sized company and a large company.
Depending on the company-specific requirements and complexity of the selling
company, the filter criteria may be modified. However, this case applies equally to
mid-cap and large-cap companies.
48 3 M&A Sales Process

A difference between a mid-cap and a large-cap company sale can be seen in the
scope of the long list. For smaller companies from a polypolistic1 market environ-
ment, the list of potential buyers can include hundreds of names. This increases the
analysis effort on the part of the M&A consultant immensely and identifying optimal
purchase candidates becomes more difficult by the amount of data. For large
companies, a different picture can be derived. Due to their size and the omnipresent
industry consolidation, the important large companies often operate in an oligopo-
listic2 market environment. This circumstance can contribute to the fact that the long
list is made up of only a few names. Conversely, the intensity of competition
automatically decreases and, if the selected buyers show little interest in buying,
the sale of the company becomes much more difficult (Iannotta, 2010, p. 122).
Conversely, small companies can operate in a market niche and large companies in a
broad competitive field. The exact constellation is highly industry dependent.
Furthermore, buyers for target companies from the lower midmarket segment
often come from traditional owner-managed midmarket. In contrast to listed
companies, the sources of information available to evaluate these buyers (e.g.,
annual reports, press releases, analyst reports, etc.) are often very limited or hardly
available due to the legal form and size of the company (Wirtz, 2012, p. 192). As a
result, the preparation of a qualified long list and subsequent reduction to a short list
is considerably more difficult for the M&A advisor.

3.1.6.3 Checklists: Filter Criteria for a Long List and for a Short List

Important
Checklist: Filter criteria for a long list
• A long list contains a rough selection of as many suitable buyers as
possible.
• Typical filter criteria for companies that make it to the long list are:
1. Clear relation to the target company’s field of activity (strategic fit)
2. Financial data (e.g., sales, EBITDA, etc.)
3. Sufficient financial strength available to handle acquisition financing?
4. Ownership structure and degree of control
5. Market position of the potential buyer
6. Number and profile of employees
7. Product and customer portfolio
8. Production sites and distribution network
9. Potential synergy effects

1
A polypoly is characterized by numerous suppliers and demanders.
2
An oligopoly is characterized by a few of suppliers and demanders.
3.1 Phase I: Preparation Phase 49

Important
Checklist: Filter criteria for a short list

• The Short List contains a selected number of the most suitable buyers to be
approached for the next M&A phase.
• Typical filter criteria for the short list are:
1. Maximum and minimum sales volume
2. Geographic location
3. Business experience
4. Market share
5. Reputation
6. Corporate culture
7. Wishes of the target company (e.g., exclusion of certain direct
competitors)
8. Special strengths, such as R&D, sales, or production
9. Listed or privately held

3.1.7 Documentation

The preparation of the sales documents, such as the information memorandum or the
anonymous short profile, and other process-relevant documents is of great impor-
tance in the M&A sales process. For this reason, the most important documents with
regards to a company sale are presented in detail below.

3.1.7.1 Information Memorandum

" Definition The information memorandum (also called info memo, memorandum
or IM) is a central sales document in the M&A process and contains a detailed
description of the company for sale.

The seller’s investment bank or M&A boutique prepares the information memoran-
dum and distributes it to the potential buyers in the shortlist at the time of market
approach. They have the opportunity to use the information memorandum as a
reference during the sales process. As a rule, it is strictly forbidden to use the Info
Memo (neither electronically nor physically). Other common names for this docu-
ment in the English-speaking world are:

• Marketing book
• Offering memorandum
• Confidential business report (CBR)
• Prospectus
50 3 M&A Sales Process

The memorandum is a comprehensive report which contains essential informa-

tion about the target company. On the basis of this information, a potential purchaser
can form a realistic opinion of the current situation and future development of the
company. In this way, a potential acquirer can identify possible synergy effects as
well as evaluate the strategic fit of the target company with regard to his own
company (Ernst & Häcker, 2011, p. 46).
As a rule, the level of disclosure of information in the memorandum is coordi-
nated in such a way that a serious prospective buyer can make an initial non-binding
purchase offer for the target company on the basis of the information in the info
memo. At the same time, it must be ensured that no highly sensitive company
information is disclosed even before the due diligence phase; otherwise, the com-
pany up for sale could be damaged.
The information memorandum should cover the following key topics (Ernst &
Häcker, 2011, pp. 46–47):

• The motivation for the sale

• An accurate and thorough description of the company for sale and its business
activities (including organizational structure, historical development, shareholder
or partner structure, product range, markets, customers, production, technology,
suppliers, competitive advantages, financial data)
• Sufficient relevant information must be disclosed to enable a potential buyer to
make an informed purchase decision.
• Confidentiality must be ensured so as not to compromise the transaction value
and that the transaction is not jeopardized.

An information memorandum usually includes the following items:

1. Introductory notes to the memorandum

2. Executive summary (also called management summary)
3. Subject of the transaction
4. Investment considerations
5. Company profile
6. Range of products and services
7. SWOT analysis
8. Markets and competitors
9. Production and manufacturing
10. Sales and Marketing
11. Management, employees, and organization
12. Financial data (of the last 3 years and planning for 3–5 years)

The memorandum should aim to present the sales object as positively as possible
with a high standard of linguistic formulation. At the same time, it is advisable from
the seller’s point of view to present the potential buyers with a fair and truthful a
picture of the target company. If the memorandum contains dishonest information or
conceals important information, this will be uncovered during the subsequent due
3.1 Phase I: Preparation Phase 51

diligence at the latest. The information memorandum is a good opportunity for the
seller to create a certain level of trust with the potential acquirers by reducing
existing information asymmetries, which can be advantageous during due diligence
and in subsequent purchase agreement negotiations.

3.1.7.2 Short Profile

" Definition An anonymous short profile (teaser or short profile) is a highly

condensed document (usually one to two pages) and is often derived from the
executive summary of the information memorandum.

In the short profile, the name of the target company is not yet revealed, but is
protected by a suitable project name (e.g., for a battery manufacturer: name with
reference “Power” or name without reference “Hibiscus”).
The aspect of anonymity is of high importance when creating a teaser, since direct
competitors are often contacted as potential buyers of the target company and such
sales information may have a negative impact on the company’s position in the
market.
An anonymous short profile usually contains the following information:
1. A brief overview of the target company and its areas of activity
2. Important facts about the company (e.g., regional activity, legal form, etc.)
3. Important financial figures (e.g., sales, EBITDA, etc.)
4. Investment considerations and opportunities (why exactly should the investor
acquire this company
5. Object of transaction and transaction background

A teaser must be appealing to a potential investor and arouse his interest in the
target company in the long term. The art of writing a good short profile is to provide
the interested buyer with just enough relevant data to decide whether to be interested
in the transaction or to dismiss the investment opportunity. On the other hand, it must
be ensured that the seller cannot be identified from the short profile (Ernst & Häcker,
2011, p. 46).

3.1.7.3 Confidentiality Agreement

The preparatory phase of the sales process ends with the preparation of the confi-
dentiality agreement, which is also called a non-disclosure agreement (NDA).

" Definition A confidentiality agreement serves to protect confidential informa-

tion. In it, both the seller and the potential buyer undertake to maintain absolute
confidentiality about the transaction project and the confidential information
exchanged.

Since early public disclosure of a planned company sale can damage the business
operations of the seller and the potential buyer, there must be a certain mutual
understanding regarding confidentiality so that the likelihood of such a negative
52 3 M&A Sales Process

event is reduced. A serious buyer needs detailed information before negotiations

begin in order to solidify his interest in the target company and to be able to
determine a purchase price range. On the other hand, a cautious seller should request
detailed information from the interested buyer to better assess its ability to handle the
acquisition financing (Ernst & Häcker, 2011, p. 42).
From a seller’s perspective, the primary objective of a confidentiality agreement
is to contractually bind a potential buyer in an M&A project to maintain confidenti-
ality about the proposed transaction and all related highly sensitive information
(Exler, 2006, p. 32).
As a rule, the confidentiality agreement contains the following core elements
(Ernst & Häcker, 2011, p. 42):

• Confidential information may not be disclosed to third parties unless they join the
confidentiality agreement.
• Direct contact with employees of the target company is not permitted.
• Upon request of the target company or upon the termination of the contract
negotiations, all information received must be returned to the seller at the latest.
• The confidentiality agreement is not a guarantee of a subsequent transaction.
• After termination of the confidentiality agreement and the associated termination
of the transaction, the interested buyer must refrain from hiring employees of the
target company, as a rule for a period of 1–2 years (non-solicitation clause).

An interested investor receives access to non-public and confidential data of the

target company after the transmission of the signed NDA. Also, the M&A advisor
informs him of the name of the target company.
In the event of a breach of the contents of the confidentiality agreement by a
potential buyer, claims for damages will arise on the seller’s side. The target
company regularly faces a problem when asserting such a claim for damages. If an
interested investor commits a breach of contract, the target company must be able to
prove this breach due to the prevailing reversal of the burden of proof, which is
usually extremely difficult. Finally, the legal effectiveness of the confidentiality
agreement in practice must be viewed critically. The moral aspect is more relevant.
In the M&A business world, no serious participant can afford to break confidential-
ity. The associated negative reputation would exclude him from future transactions.

3.1.7.4 Differences in the Documentation for Medium-sized Companies

and Large Companies
The content requirements for the sales documents concerning an M&A sale project
are generally similar for medium-sized companies and large corporations.
As the size of a company increases and the complexity of a sales transaction often
increases, as a result, the scope of an information memorandum regularly increases.
The reasons for this are usually to be found in the broader organizational structure,
product range, or business activities of large companies. Concerning a confidential-
ity agreement for a large target company, exclusivity agreements that grant a
potential buyer exclusivity under various conditions are also conceivable (Bühler
3.1 Phase I: Preparation Phase 53

& Bindl, 2012, p. 184). In case of large listed companies, NDAs additionally contain
so-called standstill agreements. They oblige the potential investor not to acquire any
shares/stocks in the listed target company or otherwise gain influence over the target
company for the duration of the confidentiality period (Bühler & Bindl, 2012,
p. 186).
When drafting the information memorandum for owner-managed SMEs, more
attention should be paid to the seller’s motivation for selling. Potential investors
usually ask “why should the target company be sold” and imply that negative factors
could drive the sale proposal (Marks et al., 2012, p. 97). For this reason, the sales
documents of a medium-sized target company should openly and plausibly state the
intention to sell.

3.1.7.5 Checklists: Information Memorandum, Anonymous Short

Profile, and Confidentiality Agreement

Important
Checklist: Information Memorandum
• The information memorandum is a comprehensive report containing essen-
tial information about the target company which a potential investor should
use to form a realistic opinion about the investment opportunity.
• Typical contents of an information memorandum are:
1. Introductory notes to the memorandum
2. Executive summary
3. The subject of the transaction
4. Investment considerations
5. Company profile
6. Product and service spectrum
7. SWOT analysis
8. Markets and competitors
9. Production and manufacturing
10. Sales and Marketing
11. Management, employees, and organization
12. Financial data (of the last 3 years and planning for 3–5 years)

Important
Checklist: Anonymous short profile

• An anonymous short profile is a usually two-page document that contains

essential information about the planned company sale and the target com-
pany in an anonymous form.
• Typical contents of an anonymous short profile are:

(continued)
54 3 M&A Sales Process

1. A brief overview of the target company and its areas of activity

2. Important facts about the company (e.g., registered office, legal
form, etc.)
3. Important financial figures (e.g., sales, EBITDA, etc.)
4. Investment considerations and opportunities (Why should the investor
acquire exactly this company?)
5. Transaction object and transaction background

3.2 Phase II: Market Approach: Point of No Return

Once the preparatory phase of an M&A sales transaction has been successfully
completed by finalizing the sales documents, the next step on the agenda of the
investment bank or M&A boutique is to contact potential buyers on the shortlist. In
this context, one often speaks of the point of no return, since at this time, the target
company’s intention to sell is irrevocably circulated, despite confidentiality
declarations. It is of great importance that the market approach only takes place
after well-founded preparation, otherwise time delays can cause a significant weak-
ening of the momentum.
After an appropriate review period of the submitted sales documents, interested
investors are given the opportunity to submit an indicative offer. The offers are then
evaluated by the M&A advisor, in close consultation with the seller, and contribute
significantly to the selection of the most suitable buyers. In line with the motto all
that glitters is not gold, companies identified as suitable buyers whose indicative
offers are unattractive are eliminated from the sales process at this point. With the
remaining selection of buyer companies, the transaction project is pushed forward.
The following section explains how a typical market approach and the selection
of the most suitable investors.

3.2.1 Addressing Potential Buyers

The process of approaching potential buyers usually begins with an initial telephone
call between the M&A consultant and a decision-maker from the selected investor.
On the basis of this conversation a first acquaintance takes place and it can be
examined whether a general purchase interest in the anonymously presented target
company exists. A willing buyer then receives an anonymous short profile of the
company for sale by personalized e-mail, together with a confidentiality agreement.
If, after reviewing the teaser, an investor is still interested in the investment
opportunity and has submitted the signed NDA to the M&A advisor, he will receive
the detailed information memorandum in another e-mail and thus also information
about the name of the target company.
3.2 Phase II: Market Approach: Point of No Return 55

3.2.2 Letter of Intent

On the basis of the information memorandum and personal discussions with the
M&A advisor of the target company or directly with the seller, each prospective
buyer contacted is asked to submit a non-binding offer. The non-binding offer is also
referred to as a letter of intent (LOI) or indicative offer. If the target company is a
medium-sized enterprise, intensive discussions are often held before the LOI is
submitted, the results of which are incorporated into the LOI. In addition, the LOI
for medium-sized targets often contains key points for the subsequent purchase
agreement. In contrast, the LOI for large target companies is regularly more stream-
lined, as it is often only drawn up on the basis of the information memorandum.

" Definition A letter of intent is a declaration of intent with the character of a

preliminary contract, from which, as a rule, no legal binding of the potential buyer or
seller results. Generally, the letter of intent can be issued by the potential buyer alone
or by both parties (Wirtz, 2012, p. 203).

In essence, the non-binding offer signals the serious interest of the buyer to enter
into detailed negotiations and to sign a purchase agreement under certain conditions.
In addition, the result of the negotiations between the buyer and the seller that has
already been reached is recorded in writing in this document, thus removing these
points from further discussion. This means that the subsequent contract negotiations
can be more efficient. In the M&A process, the letter of intent can certainly be
regarded as a stage victory with a psychological effect on negotiations, as it
underpins the seriousness of the purchase interest on the one hand and creates a
basis of mutual trust on the other (Preisser & Cavaillès, 2011, p. 18).
In the LOI, the potential purchaser provides a brief overview of the structure of
the transaction and its strategic goals with regard to the transaction. Of particular
interest is a statement about the payment method (e.g., payment in cash or in shares).
A preliminary purchase price is often expressed as a price interval or as a multiple of
an earnings figure (e.g., purchase price ¼ 6.5 x EBITDA2022E). In addition, it
specifies what type of data must be exchanged between the two parties and the
planned duration and intensity of the due diligence. A further important component
of the LOI can be an exclusivity agreement. Most often in mid-market M&A
transactions, the potential buyer requests a right of first refusal for the sale process
moving forward and asks the seller to cease negotiations with other prospective
buyers until the due diligence is completed and its binding purchase offer is
submitted (Ernst & Häcker, 2011, p. 48).
In larger M&A transactions, exclusivity is excluded because the investment bank
or M&A boutique wants to achieve the highest possible purchase price through a
parallel negotiation process with several bidders.
The typical contents of a letter of intent are (Nüsser, 2010, pp. 282–283) (Wirtz,
2012, p. 204):
56 3 M&A Sales Process

1. Preamble
2. Description of the intended transaction
3. Description of the negotiation status reached (incl. purchase price/purchase price
formula, payment modalities, liability resp. guarantees of the seller, etc.)
4. Letter of intent to continue negotiations
5. Determination of the further procedure (e.g., upcoming milestones, due
diligence, etc.)
6. Granting of negotiation exclusivity (interested party may be granted negotiation
exclusivity for a certain period of time)
7. Arrangement for bearing the costs in the event of a breakdown in contract
negotiations or breach of exclusivity
8. Confidentiality agreement
9. Due diligence agreement (e.g., period, type of information provision, data room
rules, etc.)
10. Reservation of required approvals of certain corporate bodies or antitrust
authorities
11. Other (e.g., severability clause, agreement on place of jurisdiction, etc.)

Due to the fact that the letter of intent is not intended to create a legally binding
obligation to conduct contractual discussions or to conclude a purchase agreement,
the words and statements must be chosen carefully. However, a complete disclaimer
is extremely complicated in practice. Nevertheless, a well-written LOI can signifi-
cantly reduce the extent of liability on both the seller’s and the buyer’s side (Ernst &
Häcker, 2011, p. 48).

3.2.3 Selection of Preferred Potential Buyers

After the investment bank or M&A boutique has received the indicative offers from
the prospective buyers contacted, the task is to reduce the number of potential
acquirers. For this purpose, the M&A advisor, in close cooperation with the seller,
analyzes and evaluates how serious and well-founded the non-binding offers are
(Rochat & Korp, 2010, p. 281). Buyers who have submitted unattractive purchase
offers are eliminated from the sales process at this point. The attractiveness of a
non-binding purchase offer is not only determined by the amount of the stated
purchase price but must also be evaluated on the basis of the solvency, payment
terms, and required seller guarantees (Rochat & Korp, 2010, p. 271). After this
selection, between three and five prospective buyers remain in the sales process,
depending on the transaction type and procedure.
3.3 Phase III: Examination of Financial Aspects 57

3.2.4 Checklist: Letter of Intent

Important
Checklist: Letter of intent

• The LOI is a declaration of intent with the character of a preliminary

contract.
• The letter of intent does not result in any legal commitment on the part of
the potential buyer or seller.
• The LOI underpins the seriousness of the purchase interest and creates a
mutual basis of trust.
• Typical contents of an LOI:
1. Preamble (description of the economic background)
2. Description of the intended transaction
3. Description of the stage reached in negotiations (incl. purchase
price, etc.)
4. Letter of intent to continue negotiations
5. Determination of the further course of action
6. Exclusivity agreement
7. Arrangement for bearing the costs in the event of a breakdown in the
contract negotiations and in the event of further continuation
8. Confidentiality agreement
9. Due diligence agreement
10. Reservation of necessary approvals of certain bodies or authorities

3.3 Phase III: Examination of Financial Aspects

No market is perfect and thus no market offers perfect information transparency. The
same applies to the market for mergers and acquisitions. There are clear information
asymmetries between sellers and potential buyers. The seller has extensive knowl-
edge about the employees, products, untapped potential, the pipeline, advantages,
and disadvantages of the organization, and the legal and tax risks of the object of
sale. While the seller knows the object of sale in detail, the situation is different for a
prospective buyer: his knowledge regarding the above-mentioned points is much
more decimated (Behringer, 2013, p. 26).
No potential buyer wants to buy a pig in a poke, even in connection with an M&A
sales transaction. For this reason, at this point in the M&A transaction, due diligence,
the subsequent company valuation for purchase price determination and the transac-
tion structuring should be carried out by all remaining interested buyers. These
points are discussed in detail below.
58 3 M&A Sales Process

3.3.1 Due Diligence

" Definition The systematic analysis of the target company by a potential buyer
before signing a purchase agreement is referred to as due diligence (DD) (Wirtz,
2012, p. 205). The term due diligence originates from Anglo-American law and
means due care required in dealings.
During the due diligence phase, the prospective buyer is allowed to closely
examine the target company based on sensitive and publicly inaccessible data.
The opportunity to analyze sensitive and internal company information allows the
prospective buyer to evaluate the target company with added accuracy. Also, the
interested buyer revises its plans regarding the transaction structure and financing
structure of the transaction, and financing requirements to close the transaction
(Ernst & Häcker, 2011, p. 331).

3.3.1.1 Motives for a Due Diligence

The motives for conducting a due diligence can be many and varied. As a rule, the
following motives of a prospective buyer require the performance of a due diligence:

• Assessing the economic viability and feasibility of the transaction

• Identifying the weaknesses and risks of the target company
• Obtaining forecasts of the relevant financial ratios and company data

An essential motive within the analysis of weaknesses and risks of the object of
sale is the identification of deal breakers. These are those issues that, if known,
would induce a potential buyer to withdraw from the M&A sales process. Classic
deal breakers are, for example, liability or environmental risks that are difficult to
calculate, as well as synergy effects that are erroneously assessed (Wirtz, 2012,
p. 206).
On the seller’s side, too, there is a clear motive for offering unrestricted due
diligence. The better or more comprehensive the information provided or disclosed
in the due diligence process, the more reliably the seller can protect itself against
subsequent warranty claims from the buyer (Wirtz, 2012, p. 206). De facto, the
attack surface for any claims for damages against the seller is reduced.

3.3.1.2 Key Functions of a Due Diligence

The aim of due diligence is, on one hand, to assess whether the target company can
meet the strategic requirements and objectives of the buyer and, on the other hand,
establish an appropriate valuation range for the target company. To achieve these
goals due diligence fulfills the following key functions in the M&A process:

• Reduction of information asymmetries

• Identification and review of synergy potentials
• Link between strategic planning and post-merger integration (PMI)
3.3 Phase III: Examination of Financial Aspects 59

Reduction of Information Asymmetries

The main task of due diligence is to reduce information asymmetry between the
informed seller and the less informed potential buyer. Information disclosure about
the target company is necessary for the following reasons (Ernst & Häcker, 2011,
p. 333):

• Sound evaluation of the transaction from a business perspective

• Preparation of a legally binding purchase offer, including determination of the
scope and content of guarantees and warranties

If there is no due diligence or a greatly reduced due diligence, the buyer will aim
for a purchase price reduction in the pricing process and demand a risk discount. In
the worst case, the buyer withdraws from the negotiations due to an emerging
mistrust.
Through the due diligence process, the seller signals to the potential buyer his
willingness to reduce existing information asymmetries between the two parties by
providing sensitive company information. The information obtained based on due
diligence enables the buyer to conduct a careful suitability check of the acquisition.
In business administration, this process is referred to as screening, analogous to the
search for potential buyers in the M&A preparation phase. The buyer is interested in
disclosing all relevant information regarding the target company. He intends to
prepare a detailed and systematic analysis to obtain the most comprehensive overall
picture of the target company. In return, the seller fears that an interested buyer could
misuse confidential information after a possible breakdown of negotiations. Espe-
cially if the buyer is a direct competitor, the holistic disclosure of information and a
conceivable misuse of confidential information poses a considerable risk. In contrast,
the seller must keep in mind that extensive potentially value-enhancing information
increases the buyer’s willingness to pay. The extent of information disclosure must
be kept by the seller at a level appropriate to the transaction (Wirtz, 2012,
pp. 206–207) (Exler, 2006, p. 36).

Identification and Review of Synergy Potentials

Another purpose of due diligence is to identify and review potential positive and
negative synergies. The information obtained during due diligence forms the basis
for determining key valuation parameters. Through a precise analysis of the dormant
potential in the target company and the probability of realizing positive synergy
effects, a more precise valuation range for the enterprise value can be determined.
For this reason, the knowledge gained through due diligence can lead to
renegotiations with regard to the non-binding purchase price amount stated in the
letter of intent.

Link between Strategic Planning and Post-merger Integration (PMI)

Another task of due diligence is to check a link between the strategic planning of the
target company and a post-merger integration (PMI) that is as smooth as possible.
After the M&A transaction has been completed by the transfer of the target
60 3 M&A Sales Process

company’s shares or its assets from the seller’s point of view, the buyer has to merge
or integrate the target company into its own group of companies. This integration
phase is referred to as the PMI phase. Due diligence enables the potential buyer to
conduct an in-depth review of the subsequent post-merger integration with regard to
potential risks or disruptive factors resulting from the target company’s current
business activities or corporate strategy (Ernst & Häcker, 2011, p. 334).

3.3.1.3 Parties Involved in a Due Diligence Process

The number of people involved in the due diligence process varies depending on the
size of the potential acquirer and the target company.
On the part of a potential acquirer, its own employees are always involved in the
due diligence process. This circumstance is obvious, as only the buyer itself knows
what higher goals are being pursued with the acquisition of the target company and
which facts need to be examined in detail during the due diligence process. The due
diligence team should be composed of in-house staff from the finance department for
the financial analysis and from the legal department for the analysis of legal aspects.
In addition, it can be a great advantage if the employees responsible for analyzing
synergy potential are also responsible for post-merger integration. It is also advisable
to involve external consultants and specialists such as auditors, lawyers, investment
bankers, management consultants, tax advisors, engineers and, last but not least,
insurance experts. They offer the buyer specialized know-how in their respective
field of business and can also provide an objective assessment of the acquisition
project (Behringer, 2013, p. 152).
The extent to which the target company’s employees are involved in the due
diligence process depends largely on the transaction structure and the mutual trust
between the seller and the potential buyer. Thus, the spectrum of employees
involved can on the seller’s side, depending on the situation, can include all areas,
from production to sales, depending on the situation.

3.3.1.4 Sources of Information Regarding a Due Diligence

In the letter of intent, the buyer and seller have already agreed on the duration and
information intensity of the due diligence process. From the buyer’s point of view,
obtaining comprehensive, relevant corporate information about the target company
is indispensable for successful due diligence. Access to this information can be
granted to the buyer by means of the following sources (Ernst & Häcker, 2011,
p. 335):

• Internal sources of information

• External sources of information

Internal Sources of Information

Internal information about the target company is not available to the general public,
which is why the seller’s assistance is required at this point to provide potential
buyers with a sound insight into the company for sale. The target company itself is
considered to be the best source of internal information, even if the approach is often
3.3 Phase III: Examination of Financial Aspects 61

not completely objective. Internal information can generally be obtained in four

different ways as part of due diligence from a buyer’s perspective:

• Management presentation
• Data room
• Expert interviews
• Site visits

Management Presentation
As a rule, shortly before the opening of each data room, a management presentation
is held with the individual prospective buyers. The presentation (including the
handout) is prepared in close cooperation between the management and the invest-
ment bank or M&A boutique of the target company. Before starting work on the
management presentation, it should be clarified what purpose the presentation is to
serve (Bühler & Bindl, 2012, p. 190):

• Should only the management of the target company be presented in person?

• Should an update be communicated in addition to the business information
already provided (e.g., current quarterly figures, the order book for the near
future, etc.)?
• Should the strategy for the next business years be explained?

In terms of content, a management presentation often deals with investors’

unanswered questions as well as further details about the company and the corporate
strategy that are not apparent from the information memorandum or other sources
(Mohr & Bärtl, 2012, p. 246). Also, the presentation is a useful opportunity for the
potential buyers to have the previously reviewed sales documents confirmed once
again and to clarify any queries directly with the management level. In this way, the
attitude of management toward the M&A transaction can also be ascertained and
important conclusions can be drawn from it.
From the seller’s point of view, the management presentation is intended to
strengthen the other potential buyers in their intention to buy and to dispel existing
acquisition concerns. It is therefore of great importance that this presentation is filled
with life, presented interestingly and appealingly, and that actually added value is
created for the investors. It is also the goal that the respective investor hears the
equity story of the target company from the management’s point of view and not
from the M&A advisor’s point of view (e.g., in the information memorandum), thus
underlining the commitment as well as the capability of the current management.
The management presentation should be prepared in writing with the utmost care
and there should be no deviation from this outline. The background to this is the
possibility of an acquirer making the contents of the presentation the subject of
subsequent guarantee agreements. The management of the target company should
therefore be prepared extremely conscientiously for the presentation by the M&A
advisor (Bühler & Bindl, 2012, p. 190).
62 3 M&A Sales Process

Data Room
The best way to respond to a due diligence request is to prepare and set up a data
room by the seller and its advisors.

" Definition A data room is a physical or electronic data pool that contains a
variety of essential information about the target company that the seller wants to
make available to potential buyers for analysis.

Key documents include, but are not limited to.

• Annual reports
• Reporting information for tax authorities
• Contribution margin statements for individual products
• Compensation and benefit arrangements
• Pension provisions
• Environmental reports
• Contracts with credit institutions
• Employment contracts
• Patents

If a vendor due diligence was performed by the seller in advance of the transac-
tion, the VDD report is also made available to potential buyers. As a rule, the data
room does not contain all, but nevertheless much more sensitive information about
the target company than, for example, the information memorandum or the manage-
ment presentation (Preisser & Cavaillès, 2011, p. 17) (Ernst & Häcker, 2011, p. 336).
A physical data room is understood to be the collection of relevant corporate
documents in a specified location or room (often at the seller’s attorney’s office). In
this room, extensive documents are made available for review by potential buyers,
which may not be taken from the data room. The documents must be viewed and
checked within the walls of the physical data room during specified opening hours
and under certain data room rules.
In the meantime, electronic data rooms accessible via the Internet have
established themselves as the market standard for M&A due diligence. They are
regularly structured according to the respective divisions of the target company and
organized according to a PC folder structure. To protect the electronic data room
from unauthorized persons, it is specially encrypted and password-protected (Bühler
& Bindl, 2012, p. 188). Compared to a physical data room, an electronic data room
offers advantages over a physical data room, also with regard to international
corporate transactions (Preisser & Cavaillès, 2011, p. 18) (Iannotta, 2010, p. 125):

• Several prospective buyers get simultaneous access to extensive data sets.

• Potential buyers are not bound to opening hours (data is available 24 hours a day).
• Cost savings (e.g., travel expenses of prospective buyers, etc.).
• Seller does not have to provide personnel and space.
3.3 Phase III: Examination of Financial Aspects 63

• Prospective buyers leave a digital trace in the electronic data room, allowing the
seller to analyze the behavior of individual buyers.
• In the event of legal disputes, the disclosure of relevant data by the seller can be
relevant data by the seller can be proven in the event of legal disputes.

The digital trail proves to be one of the greatest advantages of an electronic data
room from the vendor’s point of view. It enables the seller to track exactly how much
time a particular prospective buyer has spent in the data room or which documents he
has viewed, how often, and for how long. On one hand, this makes it possible to
assess the seriousness of the buyer’s interest and, on the other, to draw conclusions
about the bidding process or any reasons for reducing the purchase price. In addition,
in the event of subsequent legal disputes, the electronic trace of each potential buyer
can be used to prove his access to the relevant information in the electronic data
room (Preisser & Cavaillès, 2011, p. 18) (Iannotta, 2010, p. 125) (Bühler & Bindl,
2012, p. 188).
However, there are also certain disadvantages associated with an electronic data
room. The networking of the data room with the Internet creates clear security gaps
for the vendor in terms of the confidentiality of the information. Unlike the physical
data room, control over the information is lost as a key security factor. In addition,
with a certain degree of dexterity, data that has not been approved for reproduction
can be downloaded from the electronic data room or documents can simply be
photographed (Bühler & Bindl, 2012, p. 188).

Expert Interviews
Depending on the size, complexity, and risk potential of the sale transaction, expert
interviews can be conducted during due diligence between various division
managers of the seller and potential buyer. Further interlocutors would thus be, for
example, divisional managers, accountants or sales managers, who are consulted as
an internal source of information (Ernst & Häcker, 2011, p. 337). In order to avoid a
refusal attitude of the target company’s employees toward the transaction and an
exodus of certain key persons, the fact that a sales process is underway should also
remain confidential during the expert interviews.

Site Visits
Site visits allow a potential buyer to make sure that the seller has drawn a realistic
overall picture of the target company in the information memorandum and the
management presentation, and to check whether the substance described (e.g.,
machinery, etc.) is actually available. In addition, the buyer can get to know the
seller’s corporate philosophy better. During the inspection of the facilities, attention
should also be paid to the infrastructure and the condition of the real estate.
Furthermore, during an inspection, the buyer has the opportunity to take a closer
look at the business activities and processes and possibly identify weaknesses that
could drive up the costs of the post-merger integration.
64 3 M&A Sales Process

External Sources of Information

In addition to internal sources of information, the buyer may gather and evaluate
information about the target company from publicly available (external) sources.
External sources of information include annual and quarterly reports, credit rating
agencies, newspapers, stock market reports, and Internet sources. Former employees
and business partners of the target company can also be valuable sources of
information, as they can provide the potential buyer with a deeper insight into the
object of sale. Other external sources are main competitors, suppliers, customers,
banks, or auditors. From the buyer’s point of view, these external sources of
information are essential both for preparing for the management presentation and
expert interviews and for checking the reliability of the information received. Here,
too, confidentiality must be granted without fail.

3.3.1.5 Elements of a Due Diligence

Once the main areas of interest and the parties involved with regard to due diligence
have been determined and responsibilities have been assigned to the parties
involved, the due diligence team can begin with the respective due diligence
(Ernst & Häcker, 2011, p. 343). Here, the intensity and ultimately the outcome of
due diligence depends on whether a potential buyer already has in-depth knowledge
of the target company’s business activities, market and regional customs (including
national law) prior to the M&A transaction, or whether it is completely an uncharted
territory. Which individual elements of due diligence are performed to what degree
is additionally influenced by individual characteristics of the target company (e.g.,
chemical company versus advertising agency) (Behringer, 2013, p. 150)?
The most important due diligence reviews, which are highlighted in detail below,
include:

• Strategic due diligence

• Financial due diligence
• Legal due diligence
• Tax due diligence

Strategic Due Diligence

" Definition A strategic due diligence enables the prospective buyer to thoroughly
examine whether it will be able to achieve its strategic goals if the planned acquisi-
tion is carried out.

Unlike the other elements of due diligence, it does not look for deal breakers, but
rather for a positive rationale for proceeding with the M&A transaction (deal maker)
(Behringer, 2013, p. 152). Strategic due diligence makes an important contribution
by providing relevant information that improves the accuracy of the estimated fair
market value of the target company. Unlike other due diligences, the focus of
strategic due diligence is on the future development of the target company and not
on the results achieved in the past.
3.3 Phase III: Examination of Financial Aspects 65

The analysis of the historical development and the current situation of the target
company are components of the other due diligence reviews. These are mainly aimed
at identifying certain risks and obtaining information in order to be able to make
statements about the appropriateness of the target company’s future objectives. Most
of the fair market value of a company lies in the future (e.g., based on discounted
cash flow analysis up to 80%), represented by future cash flows and terminal value.
Therefore, a future-oriented analysis of the target company or its business plan is
crucial.

Assessment of the Forecasts of the Target Company

Before examining each assumption of the seller’s financial forecast in the context of
its business plan, past forecasts must be examined for their quality. To do this, one
compares the expected and realized figures of the target company. The smaller the
difference between the target and actual results, the higher the reliability of the future
forecasts.

Preparation of a Business Plan

Within the scope of strategic due diligence, the business plan represents an essential
object of investigation. It describes the strategy of the management and also includes
the value creation factors of the company.
A well-designed business plan consists of several categories. First, it must be
determined in which industry and in which market the company is active. The
current or potential customers and their respective needs must be identified. The
second step is to evaluate the industry or market to determine the critical success
factors for the target market. The third part of the business plan focuses on the
strengths and weaknesses of the company compared to its competitors. Besides, core
competencies, as well as competitive advantages, are determined.
The next step is to define the corporate mission statement. The target markets,
sales channels, and the products or services offered are identified. Furthermore, the
strategic corporate goals are defined (e.g., sales growth rate, market share, or sales
volume). The goals should be measurable and realizable within a certain achievable
period of time. The final step in creating a business plan is to determine a strategy
that is most likely to meet the company’s goals within a reasonable period of time
(Ernst & Häcker, 2011, p. 344).

What Happens to the Business Plan?

The strategic due diligence team has the task of reviewing the underlying
assumptions and forecasts of the target company’s business plan. These assumptions
and forecasts relate in particular to factors both within and outside the seller’s
control. The findings obtained in the course of the strategic due diligence result in
changes to the seller’s business plan. Subsequently, the contents of this adjusted
business plan are finally confirmed by the financial due diligence team. The business
plan forms the basis for determining the acquisition price and checking whether the
planned M&A transaction can generate the expected added value for the prospective
buyer. Together with the information from the due diligence, the business plan
66 3 M&A Sales Process

enables the determination of a price range for the target company (Ernst & Häcker,
2011, p. 344).

Assessment of the Business Plan

The assessment of the business plan includes the analysis of the environment of
the target company. Within the scope of this assessment, both the current state of the
target company and its most probable development are examined. Subsequently, the
underlying assumptions of the target company’s current business plan can be
questioned. This analysis focuses mainly on factors that are outside the control of
the target company and the buyer. Looking at the global environment of the target
company, developments that have a direct influence on the company are of decisive
importance. Depending on geographical location, both national and international
aspects must be taken into account. After the buyer has gained an insight into the
probable course of external market factors, he should use this knowledge to closely
examine the target company’s business plan. The strategic due diligence team now
looks at the target company’s value chain. The following describes the review of
some stages of the value chain:

• The production processes: A thorough examination of production processes

provides important information on cash flows that can be realized in the future.
In a competitive environment, a cost-efficient production process is critical. The
prospective buyer should gain insight into whether available capacity and
employees are being fully utilized or whether there is still excess capacity in
the target company. It is important to know whether the company has the
necessary capacity to meet the projected growth or whether potential bottlenecks
exist (Ernst & Häcker, 2011, p. 345).
• The procurement process: The business activities of purchasing and their interac-
tion with other departments should also be examined. The analysis of the pur-
chasing should reveal whether the target company has the necessary purchasing
power or is forced to respond to supplier demands without bargaining power.
• Management and other employees: The performance of the target company’s
employees has a major impact on the success of the M&A transaction. Also, the
company’s management situation should be thoroughly examined, especially if
management is to remain with the company after the transaction is completed.
Interviews should be conducted with the management to find out their attitude
toward the transaction and to get a better understanding of the general corporate
culture.

Financial Due Diligence

" Definition The function of financial due diligence is to provide the potential
buyer with an accurate and objective picture of the target company’s net assets,
financial position, and results of operations (Wirtz, 2012, p. 209).

The analysis is both past- and future-oriented. The financial due diligence team often
consists of external consultants (e.g., auditors). These are to check whether all assets
3.3 Phase III: Examination of Financial Aspects 67

and equity exist as previously reported by the seller and whether both liabilities and
provisions are correctly recorded and appropriately valued in the balance sheet.
Also, one of the tasks of the financial due diligence team is to determine the level
of sustainable profit and cash flows of the last financial years, based on the target
company’s income statement.

Examination of the Internal Control System

To make a statement about the quality of the seller’s business reports, the prospec-
tive buyer must assess the strength of the target company’s internal control system
(Ernst & Häcker, 2011, p. 349). The internal control system primarily includes
accounting, cost accounting, and IT systems. If the company has a strong internal
control system, the risk of post-merger integration problems is significantly lower.

Audit of Corporate Reports

The audit of the annual financial statements as well as of the monthly past years is the
most important factor of financial due diligence. It is, from the buyer’s point of view,
mainly about understanding whether the planned development of the target company
can be reasonably justified. Because of this, it is necessary to determine relevant key
figures based on the balance sheet and the income statement. The former provides
information on the financial situation and the latter on the current status of the
company. The prospective buyer should always be aware of possible weaknesses
in the financial documents of the target company. For financial due diligence, data
from the following sources are used:

• Annual financial statements

• Quarterly figures
• Budget planning
• Strategic planning
• 5-year planning
• Audit reports

Legal Due Diligence

" Definition A legal due diligence serves as a safeguard against potential legal
obligations of a potential buyer and also rounds off the economic framework
analysis, which is used to determine the value and profitability of the target
company.

It is particularly important to question whether the economic activities are carried out
in a legally incontestable manner (Ernst & Häcker, 2011, p. 353). Therefore, the
prospective buyer or its legal advisors should examine whether the target company is
exposed to hidden liability risks and whether any problems with antitrust law might
exist with regard to the desired transaction closing. In the course of legal due
diligence in international corporate transactions, specialized law firms with profound
know-how of the respective national law are indispensable as M&A advisors for a
68 3 M&A Sales Process

prospective buyer; they can also provide advice on the legal aspects of the
transaction.
During due diligence the legal review plays an essential role. Through the legal
review, the buyer assesses, among other things, whether the target company
approaches legal issues with competence and caution. Legal due diligence focuses
on the following main areas:

• Legal basis
• Legal risks
• Internal legal relationships
• External legal relationships

The Legal Basis

The legal due diligence team checks the legal personality of the company, the
existence of a solid and enforceable partnership, the current excerpts from the
commercial register, the involvement of third parties, and the internal regulations.

Legal Risks
For the potential acquirer, both existing and threatened litigation and key contracts
may pose legal risks. Concerning contracts, it is examined whether and for how long
the potential acquirer will still be bound by existing contracts of the target company
after the transaction. Particularly important is the examination of labor law
provisions, such as works agreements, trade unions within the company, or collec-
tive bargaining agreements (Ernst & Häcker, 2011, p. 353).

Internal Legal Relationships

The most important internal legal relationships are the employment contracts with
employees and managers. The buyer examines the way in which employment
contracts could be terminated and the extent of any resulting costs (e.g., severance
payments) (Ernst & Häcker, 2011, p. 354). On one hand, it is important to clarify that
no imminent ordinary terminations of certain key personnel are planned in the target
company. On the other hand, relationships that are too long should be avoided so that
key personnel do not make a desired or necessary change deemed by the buyer to be
unnecessary or expensive. If the buyer discovers an impending unfavorable change
in personnel during legal due diligence, he will want to have a warranty obligation in
the purchase agreement that requires the potential acquirer to be compensated by the
seller in the event of an adverse change in personnel.

External Legal Relationships

The external legal structure consists of standard contracts for repetitive business
activities. These include standard employment contracts or general terms and
conditions. Furthermore, cooperation agreements, major contracts, rights of use,
material leasing contracts, insurance policies, and patents must be sifted through.
3.3 Phase III: Examination of Financial Aspects 69

Tax Due Diligence

" Definition The purpose of tax due diligence is to examine the tax situation of the
target company and the identification of the tax risks (Behringer, 2013, p. 157).

The decision for or against a company acquisition is often not based on tax
objectives on the part of the prospective buyer. Nevertheless, tax aspects are
important, as they have a great financial significance and at the same time a certain
degree of freedom in structuring.
Tax due diligence pursues one essential goal. Tax risks from the target company’s
previous years, which may oblige the potential acquirer to incur financial liabilities
to the tax authorities following the M&A transaction, are to be uncovered. In this
respect, tax due diligence is similar to an early tax audit. However, it goes beyond
that and reduces post-merger integration risks related to insolvency and liability by
reducing tax expenses from the acquisition and sale of another company or its assets
(Ernst & Häcker, 2011, p. 355).
The following documents form the basis for tax due diligence:

• Tax returns from previous years

• Reports from tax audits
• Financial plans
• Agreements with tax authorities

3.3.1.6 Differences in a Due Diligence for Mid-cap and Large-cap

Companies
The due diligence phase of an M&A transaction is similar at the higher level for
mid-cap and large-cap transactions. However, several differences can be identified
when diving into detail.
While the motives for implementing due diligence are similar for both a mid-cap
and a large-cap target company, a divergence can already be seen in key functions of
a due diligence process. Because of the information asymmetries between sellers and
potential buyers, their reduction is particularly important for medium-sized target
companies. Due to their choice of legal form and other factors, many SMEs are
subject to lower disclosure requirements than large companies. Thus, a prospective
buyer can form a less complete picture of a medium-sized company based on
publicly available information compared to large companies. As a result, special
attention should be paid to reducing information asymmetries among medium-sized
target companies. However, large companies should also be interested in reducing
existing information asymmetries to a large extent.
Based on the management presentation, another difference between SMEs and
large companies can be identified. Particularly in the lower SME segment, there is
often no business plan and the management consists of a few managing partners. In
the context of the management presentation, it can be of great importance that the
strategy for the next business years, which often only rests in the heads of
entrepreneurs, is described to potential buyers in a comprehensible way. The situa-
tion is different for large companies. During the management presentation, as a rule,
70 3 M&A Sales Process

the first and second management levels, as well as other management personnel
(e.g., sales managers and the head of accounting), introduce themselves personally
(Exler, 2006, p. 31). Also, the management presentation has another function in
many large companies. If the existing management, which is usually not made up of
shareholders, plans to remain with the company after the transaction, it must
particularly emphasize its expertise and value for the company during the presenta-
tion. However, in many medium-sized target companies, the management level
changes after the transaction are completed, as management was generally in the
hands of those shareholders, who leave the target company after being paid out based
on the purchase price.
Looking at the data space, we can see further differences between mid-cap and
large-cap transactions. The experience of the seller in relation to mergers and
acquisitions also plays a major role in terms of data space. While large companies
have more extensive staff resources and their M&A departments that can respond
sufficiently to a data room request and associated provision of information, the
situation can be different for companies in lower and mid-market segments.
Mid-sized companies generally have fewer employee resources and no internal
M&A department. All of these factors can contribute to a mid-market target com-
pany being overwhelmed by a data room request as well as the resulting information
provision due to the lower M&A experience and high workload. It is therefore even
more important for medium-sized target companies that the M&A advisor prepares
his client for such data provisions in the data room at an early stage using checklists.
Another difference between medium-sized and large companies concerning data
room can be seen in the data room size. Large companies often have more extensive
business activities, employee resources, (national and international) locations, sup-
plier and customer structures, annual financial statements, quarterly reports,
planning, etc. than mid-sized target companies. As a result, the size of the data
room increases for larger and thus regularly more complex corporate transactions, as
considerably more transaction-relevant documents can be posted by the seller. If we
focus our attention on SMEs, a high level of confidentiality and secrecy plays a
decisive role in the day-to-day business of many SME entrepreneurs. As a result, a
certain dismissive attitude toward complete information transparency and thus
document provision can be detected. The defensive attitude becomes even more
pronounced if the circle of potential buyers includes direct competitors of the target
company. Regardless of whether they are medium-sized companies or large
enterprises, both should always keep in mind that reduced due diligence and a
decimated data room will result in extensive guarantees and warranties by the seller
in course of subsequent contract negotiations.
To prevent the risk of misuse of confidential information, it is quite common in
practice to conduct due diligence in several phases. This means that in data room
phase 1, such information is made available whose existence would not lead to any
negative consequences for the target company if negotiations broke off. As the
duration of negotiations increases and probability of success increases, more confi-
dential information is then provided in further data room phases.
3.3 Phase III: Examination of Financial Aspects 71

As the complexity and size of an M&A transaction increases, a divergence in

advisors involved in the due diligence process on part of the prospective buyers can
be observed. In large-cap transactions, the largest and most reputable accounting
firms (Big Four), law firms, etc. are regularly involved in the due diligence of the
target company on the buyer side. In general, due diligence is approached with a
broader team of advisors in large transactions. In case of smaller target companies,
fewer consultants are often used and, not the best-known consulting firms for
individual elements of due diligence are used.
While large companies can generally present a detailed business plan, various
annual reports, and planning data, a different picture emerges in the lower midmarket
segment. Here, there are regularly no well-founded business plans or planning data
on profit or cash flow development. These circumstances make it more difficult for a
prospective buyer to comprehensively assess the strategic fit between the target
company and his own company. Strategic due diligence for a small medium-sized
target company is therefore often made more difficult for a potential buyer. In case of
many owner-managed medium-sized target companies, the strategic due diligence
should examine whether there is a high degree of dependency on individual
customers and, in particular, whether certain major customer contracts are awarded
in a strong personal connection with the entrepreneur. This would be a value-
reducing factor, as a prospective buyer runs the risk of several high-revenue
customers leaving after the acquisition and the departure of the previous entrepre-
neur. In the predominantly owner-managed SME sector, in contrast to management-
managed large companies, it must therefore be examined particularly thoroughly
whether a strong person-centeredness emanates from the entrepreneur or whether
there is a broad network of responsibility in the target company.
Large companies generally have powerful accounting, controlling, and IT
systems. This is often not the case, especially in the lower midmarket segment.
For this reason, the financial due diligence of a smaller medium-sized target com-
pany should examine the status of the systems and what adjustment costs can be
expected in the post-merger integration phase.

3.3.1.7 Checklist: Due Diligence

Important
Checklist: Due Diligence
• Due diligence is a systematic analysis of the target company by a potential
buyer before signing a purchase agreement.
• Motives for conducting due diligence:
1. Assessment of profitability and feasibility of the transaction
2. Identifying the target company’s weaknesses and risks
3. Obtaining forecasts of the relevant financial ratios and company data
• Key functions of due diligence:

(continued)
72 3 M&A Sales Process

1. Reducing information asymmetries

2. Identification and review of synergy potentials
3. The link between strategic planning and post-merger integration (PMI)
• In addition to external sources of information, there are important internal
sources of information in the context of due diligence:
1. Management presentation
2. Data room (a most important source of information in the context of
a DD)
3. Expert interviews
4. Company visits
• The most important elements of due diligence include:
1. Strategic Due Diligence
A thorough examination of whether the prospective buyer can
achieve its strategic goals based on the acquisition (strategic fit).
The most important subject of examination is the business plan of
the target company. Deal makers are sought.
2. Financial Due Diligence
Determination of an accurate and objective picture of the current and
future asset, financial, and earnings situation of the target com-
pany. Deal breakers are sought.
3. Legal Due Diligence
Identification of all legal risks. Serves to hedge against potential legal
obligations, resulting from the acquisition. We are looking for deal
breakers.
4. Tax Due Diligence
Examination of the tax situation of the target company and identifi-
cation of tax risks. We are looking for deal breakers.

3.3.2 Company Valuation

Company valuations play an important role in the context of mergers and

acquisitions. From the seller’s point of view, investment banks or M&A boutiques
often carry out a company valuation of the object of sale in the run-up to the beauty
contest or directly at the beginning of the transaction. The contacted prospective
buyers or their M&A advisors will also carry out an initial indicative company
valuation of the target company after receiving the information memorandum, which
they can refine further after the due diligence phase.

" Definition A business valuation is used to determine the market value of the
equity of the company being acquired.
3.3 Phase III: Examination of Financial Aspects 73

There are reasons on both sides of the negotiation that make a business valuation
indispensable in an M&A process. On one hand, a company seller wants to know the
value range of his holding and which purchase price is to be offered. On the other
hand, a potential acquirer is also interested in the fair market value range of the target
company to determine its maximum purchase price.
So, in an M&A transaction, the seller does not want to receive too little money for
his company and the buyer does not want to pay too much for it. It is important to
develop an understanding that there is no such thing as one universal enterprise value
for a particular target company at a particular point in time. As a result of a company
valuation, there is always an enterprise value range that varies depending on the
observer (e.g., enterprise value ¼ 45 to 53 million euros), which acts as a basis for
decision-making. On one hand, the reason for this range lies in the fact that within
the scope of a valuation of a company, all of which lead to slightly strongly differing
enterprise values. On the other hand, for each valuation method, a premium and
discount of +/ 10 percent is added to the calculated enterprise value, e.g., in the
case of multiples method. 10 percent is added to the calculated enterprise value at the
end of the valuation process, and a sensitivity analysis is carried out for the DCF
methods.
The calculated enterprise value is also referred to, in specialist circles, as enter-
prise value (total enterprise value of the operating business) or entity value (enter-
prise value + non-operating assets). It consists of the sought-after market value of the
equity (equity value) and the net financial liabilities (net debt).
The valuation methods of practical relevance in the context of an M&A transac-
tion are presented below (Fig. 3.3):

3.3.2.1 Discounted Cash Flow Method

In practice, the discounted cash flow (DCF) method is considered to be the most
relevant valuation method.

" Definition In case of the discounted cash flow method, the enterprise value to be
determined is derived from the future earning power of the target company. The
DCF method interprets the enterprise value as the sum of the expected future cash
flows of the company discounted to the present (Trunk, 2010, p. 105).

The cash flows are only planned in detail for a specific period, often 5 years. This
period is referred to as the detailed planning period. For the period after detailed
planning, the so-called terminal value (residual value or going concern value of the
company) is determined as a perpetual annuity of a sustainably realizable cash flow.
The main value drivers in a DCF analysis are forecasting of future cash flows and
assumptions of the discount rate (Ernst et al., 2010, p. 27).
The WACC (weighted average cost of capital) approach, the adjusted present
value approach (APV approach), and the equity approach (net approach) are
presented below.
74 3 M&A Sales Process

Valuation methods

Discounted cash flow methods Multiples methods

WACC
APV Equity Transaction Trading
(or Entity)
approach approach multiples multiples
approach

Fig. 3.3 Valuation methods

WACC Approach (or Entity Approach)

The WACC approach represents the most widely used valuation method. Under this
approach, the cash surpluses available to satisfy the claims of all providers of
capital—i.e., both equity and debt providers—are determined (Ernst et al., 2010,
p. 28). Debt providers include those providing interest-bearing debt. Accordingly,
cash flows considered are before deduction of interest and principal payments. The
income tax resulting from debt financing is not taken into account here. The cash
flows relevant to the WACC approach are referred to as operating free cash flows3
(oFCF). These are financing-neutral and therefore independent of the company’s
financing structure. The effect of the capital structure on the enterprise value is taken
into account into the discount rate.
Operating free cash flows are discounted using an interest rate that takes into
account the return requirements of both equity and debt providers. The cost of equity
and debt are weighted according to their ratio to total capital. It should be noted that
the weighting is not based on book values but market values. The discount factor
calculated in this way is referred to as the weighted average cost of capital4 (WACC).
The tax advantage (tax shield) resulting from the deductibility of interest on
borrowed capital is also taken into account in the WACC.
Since all DCF methods only take into account the operating surpluses when
discounting, the market value of the non-operating assets, including cash, must be
calculated separately and added to the present value of operating free cash flows. The
result is the market value of total equity or the entity value. To obtain the market
value of equity, net debt5 must be deducted (Ernst et al., 2010, pp. 27–29).

Adjusted Present Value Approach

In line with the WACC approach, this approach determines and discounts the cash
flows used to satisfy equity and debt capital providers. The difference to the entity

3
See Appendix 1 for calculation formula.
4
See Appendix 2 for calculation formula.
5
See Appendix 3 for calculation formula.
3.3 Phase III: Examination of Financial Aspects 75

approach lies in different considerations of the effect of the capital structure on the
enterprise value. In the APV approach, the enterprise value is calculated by assum-
ing a fully self-financed company. Accordingly, the operating free cash flows are
merely multiplied by return claims of equity providers for the (notional) unleveraged
company, and debt is initially not taken into account.
The market value of the (notionally) debt-free company is obtained by adding the
market value of non-operating assets including cash to the present value of the oFCF
determined.
To determine the market value of the total capital of the indebted company, the
present value of the Tax Shield must be added at this point. The tax shield takes into
account the effect of the company’s debt financing. The Tax Shield is equal to tax
savings thanks to the tax deductibility of the interest on borrowed capital. In the APV
approach, the effect of tax shield is thus taken into account in isolation and not, as in
the case of the entity approach, as part of the WACC calculation.
To determine the market value of equity, the market value of interest-bearing
liabilities must be deducted from the market value of total equity of the indebted
company (Ernst et al., 2010, pp. 29–30).

Equity Approach
Under the equity approach, those payment surpluses are determined which are only
available to equity providers. Under the equity approach, cash flows resulting from
debt financing are included directly in the cash flow calculation, in contrast to the
calculation of oFCF under the entity approach. These cash flows are referred to as
cash flow to equity6 (CFtE). The cash flows to equity are discounted exclusively at
the cost of equity and not at a weighted average cost of capital.
In contrast to the entity method, the equity method calculates the fair value of
equity directly by adding together the present value of the cash flows to equity and
fair value of the non-operating assets including cash (Ernst et al., 2010, pp. 30–31).

Strengths and Weaknesses of Discounted Cash Flow Methods

A key advantage of the DCF method is that it is future-oriented when determining
the value of a company. The determined enterprise value is not based on the past but
is derived from the future earning power of the target company. For example,
possible market growth or earnings increase scenarios are also taken into account
with regard to the company to be valued.
Another advantage of the DCF method is that it takes into account the adjustment
of extraordinary income and expenses. The enterprise value is to be based on the
sustainably realizable future earnings power of the company to be valued, which is
why non-recurring events are adjusted in the calculation.
The enterprise value determined in the context of DCF methods is strongly based
on assumptions made about the company to be valued, e.g., with regard to the cost of
capital and forecast cash flows. A slight change in the assumptions made can lead to

6
See Appendix 4 for calculation formula.
76 3 M&A Sales Process

a significant change in the enterprise value. The enterprise value thus reacts
extremely sensitively to changes in the context of DCF valuations. This is precisely
why it is advisable to perform a sensitivity analysis at the end of a DCF valuation.
This shows what enterprise value would be for the company being valued under
various assumptions, such as a change in the WACC, sales growth, profit margins,
etc. The sensitivity analysis also takes into account the uncertainty regarding the
assumptions made.
In addition, the uncertainty regarding the future forecasts made about the target
company and the market development (e.g., sales or earnings growth, economic
situation, inflation, etc.) is another disadvantage of the DCF methods. The signifi-
cantly higher time required to perform a DCF valuation and the technical complexity
of these valuation methods can also be seen as disadvantages compared to other
valuation methods.

3.3.2.2 Multiples Methods

Multiples methods are the second most important valuation method in practice.

" Definition Under the multiples method, the sought-after value of the company to
be valued is determined based on multiples. These are derived from the publicly
known market values of other companies comparable with the target company.

The multiples method is based on the assumption that similar companies are
valued approximately the same as the target company (Ernst et al., 2010, p. 189).

Equity Value and Enterprise Value Multiples

Multiples can be subdivided into equity-value and enterprise-value multiples,
depending on their reference variable (Fig. 3.4).
The equity value multiples are used to determine the market value of the equity
(EqV) of the target company. Thus, the benchmark should be a financial ratio
adjusted for net interest income. Some equity value multiples are listed below:

• EqV/earnings before taxes

• EqV/net income (or price/earnings)

The enterprise value multiples are used to calculate the total value (EV) of the
target company, i.e., the market value of equity and debt. Thus, the benchmark
should be a financial ratio before interest and taxes. Some enterprise value multiples
are listed below:

• EV/Sales
• EV/EBITDA
• EV/EBIT

Enterprise value multiples have the advantage over equity value multiples in that
they are not influenced by the respective financing structure of the company. In
3.3 Phase III: Examination of Financial Aspects 77

Multiple =

Value
Reference value

Equity value multiple = Enterprise value multiple =

Equity value Enterprise value

Reference value after interest Reference value before interest and taxes

Fig. 3.4 Valuation multiples

contrast, equity value multiples are easier to calculate. The reason for this is that the
market value of the equity (equity value) of a listed company can be read directly
from the market capitalization, i.e., the product of the share price and the number of
shares. This is not the case with enterprise value or the total value of the company.
To get from equity value to enterprise value, the net debt must be added to the
market value of equity (Mohr & Bärtl, 2012, p. 268).

Trading Multiples and Transaction Multiples

In addition to the types of multiple (e.g., equity value or enterprise value), a further
distinction is made between two methods for determining multiples:

• Trading multiples method (comparable companies analysis)

• Transaction multiples method (comparable transactions analysis)

Trading Multiples Method

" Definition Trading multiples provide information on how much the company to
be valued would be worth on the stock market on a certain date if it were compared
with similar listed companies.

Accordingly, they are based on a comparison of the company being valued with
current multiples valuations of similar companies on the stock exchange.
Procedure for determining trading multiples:
In general, the valuation of a company using trading multiples follows a simple
scheme. First, comparable listed companies (peer companies) are searched for and
compiled in a peer group. This is usually done in an MS Excel table. The peer
companies should be as similar as possible to the company to be valued in terms of
business activity, cost and earnings structure, debt ratio, value chain, geographic
78 3 M&A Sales Process

presence, etc. The peer group is then compared with the company to be valued.
Subsequently, the valuation-relevant current information on the peer group
companies, such as sales, EBITDA, EBIT, profit, share price, number of shares,
equity value, net debt, etc., is compiled and prepared in MS Excel. In the next step,
certain multiples are calculated for each peer group company individually (e.g.,
EV/Sales, EV/EBIT, Price/Earnings, etc.). Subsequently, the median of the EV/sales
multiples, EV/EBITDA multiples, etc. of all peer group companies is calculated in
each case (Table 3.8).
In the final step, the aggregated multiples are multiplied by the respective
financial ratio of the company to be valued, and, depending on the multiple, the
enterprise value or equity value of the target company is obtained. If the company is
to be sold in 2020, for example, the median of all EV/EBITDA2022E multiples of
the individual peer companies (e.g., EV/EBITDA2022E ¼ 6.20x) is multiplied by
the EBITDA2022E of the company to be valued (e.g., EBITDA2022E ¼ EUR
10 million) to obtain the approximate enterprise value of the target company
(in this case EV ¼ 6.20x EUR 10 million ¼ EUR 62 million).

Transaction Multiples Method

" Definition Transaction multiples provide information on the approximate price

that would be paid for the company to be valued today based on comparable
transactions.

They are therefore based on past transactions of comparable companies.

It is important to note that transaction multiples are generally higher than trading
multiples, as they include the acquisition premium, which the buyer was prepared to
pay for the respective target company. The amount of this premium depends, among
other things, on the expected synergy effects and the strength of the bidder.
Procedure for determining transaction multiples:
When determining transaction multiples for the valuation of a specific company,
specialized databases are often searched in the first step for past M&A transactions.
In these transactions, the respective selling company should have been as similar as
possible to the company now to be valued, in terms of business activity, debt ratio,
etc. The valuation multiples for a specific company to be valued are then calculated.
Subsequently, the valuation-relevant information, such as transaction values, sales,
EBITDA, EBIT, etc., is collected for the respective selling companies and processed
in an MS Excel table. In the next step, certain multiples are calculated for each
transaction individually (e.g., EV/Sales, EV/EBITDA, EV/EBIT, etc.) or, if avail-
able, taken directly from the specialized databases. Subsequently, the median of
EV/sales multiples, EV/EBITDA multiples, etc. of all transactions is calculated in
each case, as was already done to determine the stock market multiples. In the final
step, the aggregated multiples are multiplied by the respective financial ratio of the
company to be valued. Thus, for example, one multiplies the median of all
EV/EBITDA multiples of the individual transactions (e.g., EV/EBITDA ¼ 7.63x)
by the EBITDA2022E of the company to be valued (e.g., EBITDA2022E ¼ 10 million
3.3 Phase III: Examination of Financial Aspects 79

Table 3.8 Simplified representation of enterprise value calculation in the context of a trading
multiples valuation
Enterprise value multiples
EV/sales EV/EBITDA EV/EBIT
Peer group companies 2022E 2022E 2022E
Company A 0.50x 6.20x 15.30x
Company B 1.20x 6.50x 7.30x
Company C 2.20x 8.50x 10.04x
Company D 0.20x 2.00x 2.56x
Company E 0.70x 6.90x 13.00x
Company F 0.90x 7.50x 9.76x
Company G 1.30x 8.00x 9.17x
Company H 3.70x 13.10x 15.40x
Company I 0.30x 4.90x 7.30x
Company J 0.50x 2.90x 3.20x
Company K 0.40x 4.50x 6.60x
Company L 0.50x 5.60x 7.30x
Company M 1.20x 8.20x 10.70x
Company N 0.40x 5.20x 9.80x
Company O 0.30x 5.00x 13.90x
EV/sales EV/EBITDA EV/EBIT
Min. 0.20x 2.00x 2.56x
Average 0.95x 6.33x 9.42x
Median 0.50x 6.20x 9.76x
Max. 3.70x 13.10x 15.40x

euros) and thus obtains the approximate enterprise value of the target company (here
EV ¼ 7.63x 10 million euros ¼ 76.3 million euros) (Table 3.9).

Strengths and Weaknesses of Multiples Methods

The greatest advantage of multiples is that the market serves as a valuation bench-
mark and thus market prices can be used as a good estimate. In this context, the
company value is therefore not driven by assumptions about the company to be
valued but is based on information priced in by the market.
Another advantage is the fast and relatively simple calculation of the multiples.
The extrapolation of the valuation-relevant data is less time-consuming and the most
important calculation step for the multiples methods is a simple rule of three. Thus, it
is possible to compare companies in a very short time and significant data can be
collected. Multiples can also be used when there is insufficient information to
perform a DCF valuation. In addition, it is particularly advantageous in the case of
long negotiation periods that multiples can be updated quickly and without great
effort (Eayrs et al., 2007, p. 388).
Of all things, the advantage of using the market as a valuation benchmark also
represents a significant disadvantage of multiples. In times of volatile stock market
80 3 M&A Sales Process

Table 3.9 Simplified representation of the enterprise value multiples calculation in the context of a
transaction multiples valuation
Input information Enterprise value multiples
EV/ EV/ EV/
Date Target Buyer EV (EURm) sales EBITDA EBIT
04.02.2022 A 1 245.2 0.37x 7.80x 15.24x
05.12.2021 B 2 413.5 1.42x 7.72x 9.10x
28.09.2021 C 3 405.1 0.44x 4.99x 7.82x
06.03.2021 D 4 887.7 0.55x 6.48x 12.07x
12.06.2020 E 5 96.5 1.36x n.a. n.a.
17.08.2019 F 6 105.2 0.98x 8.74x 11.54x
03.03.2019 G 7 23.7 0.61x 8.58x 14.06x
21.10.2018 H 8 73.9 0.96x 4.66x 8.88x
30.01.2018 I 9 301.7 1.18x 7.63x 11.08x
07.07.2017 J 10 81.4 0.61x 6.08x 8.00x
Min. 0.37x 4.66x 7.82x
Average 0.85x 6.97x 10.86x
Median 0.78x 7.63x 11.08x
Max. 1.42x 8.74x 15.24x

prices or strong economic fluctuations, the multiples methods can lead to strongly
fluctuating company values. As a result, the simple comparability of the company
being valued with certain peer group companies or comparable M&A transactions is
significantly impaired.
Another disadvantage is that the company-specific growth prospects and future
earnings power of the target company are not taken into account. The Achilles’ heel
of multiples is that they are based on past values. As a result, the future potential of
the company being valued gets hidden in the multiples procedure to some extent.
Another point of criticism is the dependence of the company value on the
comparability of the peer group companies. In practice, it is almost impossible to
find several companies that are virtually identical to the company being valued.
Another problem often arises from the lack of comparability of companies due to
different accounting standards (e.g., IFRS, US GAAP, etc.).

3.3.2.3 Differentiation between Value and Price

What is the difference between the price and the value of a company? Warren Buffet
once said: “Price is what you pay. Value is what you get.” It probably cannot be
expressed more aptly than that.
The price of a company is the amount of money a potential buyer is willing to pay
for shares in the company. This monetary amount results directly from sales
negotiations and represents the result of supply and demand. In the case of listed
companies, the price can be determined via the stock exchange, where supply and
demand come together via the share price.
3.3 Phase III: Examination of Financial Aspects 81

The value is the consideration for the amount of money paid for the company.
The value of a company is therefore nothing other than the benefit you derive from
the acquired company. But how can the benefit be measured? It is one of the most
challenging arguments in economics to evaluate the utility of an object for a person
because each of us has very different utility functions under different conditions.
In business valuation, models are created to determine the value of a company.
Modeling always means simplifying. This means that in a business valuation model
we limit ourselves to the most important factors that determine the value of the
company. Abstraction is made from all other things. The purpose of modeling is also
to ensure that the valuation is transparent and comprehensible to outsiders. With
regards to the methodology, a certain degree of objectification is to be achieved. And
as a relatively objective yardstick for measuring benefits and value, it makes sense to
measure the value of a company by its future success.
In practice, a fundamental distinction is made between valuation models and
pricing models. DCF methods provide the value of a company. Multiples models
provide prices of a company. Are the value of a company and the price of a company
identical quantities? They are identical only in one constellation. This is the case if
the model world of perfect capital markets can also be found in the real capital
markets, i.e., reality is similarly perfect to the world described by the model world.
Although perfect markets have never been observed in the past, technical progress,
falling tax rates and transaction costs, increasing information availability and glob-
alization meant that the model world and the real world were not far apart. This was
certainly the case until 2000, when the New Economy Bubble burst. Until that time,
the M&A business used the DCF method for valuation and the multiples method for
plausibility. Interestingly, values and prices at that time were mostly within an
acceptable range.
In today’s M&A practice, DCF valuations play virtually no role. This is due to the
premises underlying the DCF valuation models. In particular, the Capital Asset
Pricing Model (CAPM) for determining the cost of equity with its unrealistic
assumptions of perfect and complete capital markets is the reason why the results
of DCF company valuations no longer reflect the current price situation on the M&A
markets. The CAPM is only appropriate if real markets are similarly perfect as the
CAPM assumes in its model assumptions. It is interesting to note that from a
technological perspective, real markets approach the idea of perfect markets in
some respects. In a perfect market, there would be no market-influencing economic
agents, no market-influencing government intervention, or monopolistic institutions
such as central banks. Everything would be coordinated through markets in a
decentralized manner. On the other hand, real markets are moving further and further
away from perfect capital markets in other respects. For example, protectionist
measures hinder the free movement of goods and capital, and politicians have gained
more power after the financial crisis of 2008/2009 and with the Corona crisis they are
trying to regulate the markets more. Central banks use their monopoly position and
intervene in economic activity through active monetary policy. The low-interest-rate
policy has led to the allocation function of the interest rate being overridden, the
market is flooded with cheap money and economic bubbles being created as a result.
82 3 M&A Sales Process

Overall, it can be said that the degree of imperfection in the markets has risen sharply
in recent years. This has led to a widening gap between the value and price of
companies.
A major problem is that the CAPM valuation assumes a perfectly diversified
investor who, in a perfectly diversified portfolio, is only exposed to market risks
(systematic risks) which he cannot influence by his investment decision. The
investor has eliminated all company-specific risks (unsystematic risks) from his
portfolio through perfect diversification. Consequently, only systematic risks (mar-
ket risks) are included in the calculation of the cost of equity. All company-specific
risks do not influence the cost of equity. Is not that a paradox? In an M&A process, a
great deal of time, effort, and money is spent on identifying precisely the company-
specific risks and quantifying their impact in monetary terms. They have a massive
impact on further negotiations and the purchase price. In extreme cases, they can
lead to a deal being broken off. However, it is precisely the unsystematic risks that
are not taken into account in the company valuation that have the greatest relevance
for the purchase price.
For the M&A business, this means that DCF valuations no longer provide
suitable price indications. In this respect, it makes perfect sense from an M&A
perspective to fall back on price indications from the stock exchange or the M&A
market. The only problem is that although this approach reflects the price level on the
M&A market, the buyer does not know what discounted and the risk-adjusted value
he will receive in return. Until now, this question has also been uncritical, as
expansive monetary policy has continuously increased prices for companies. This
has masked the fact that many M&A transactions are carried out at a highly
overpriced price. It is often the case that the prices paid for a company exceed its
value many times over. This is reflected in the buyer’s balance sheet by high
goodwill. This procedure works smoothly as long as the purchased company is
economically successful. If the macroeconomic environment changes—as we are
currently seeing—and the economy becomes gloomy, the goodwill may have to be
written down as part of the impairment test. This runs completely counter to the
company’s equity and can have an impact that jeopardizes the company’s continued
existence.
It would therefore be important to include the entire range of entrepreneurial risks
in the company valuation. All risks, whether systematic or unsystematic, should be
made transparent and the consequences of their occurrence should be known. It is
not without reason that the Institute of Public Auditors in Germany requires that the
risk analysis includes an assessment of the scope of the identified risks in terms of
probability of occurrence and quantitative impact. This also includes an assessment
of whether individual risks, which are of secondary importance when considered in
isolation, can aggregate in their interaction or through accumulation over time to
form a risk that jeopardizes the company as a going concern. Simulation-based
business valuation can be used to adequately model all risks and their interaction and
to value companies in a way that is appropriate to the risks. Currently, these
valuation methods are being developed and tested. The goal is to use simulation-
based DCF valuation to determine company values that reflect the true risk of the
3.3 Phase III: Examination of Financial Aspects 83

transaction in terms of value. This would enable every participant in M&A

transactions to recognize whether the prices demanded on the M&A market are
justified in terms of value or not. Ideally, this would reveal excessive pricing in the
M&A market and avoid it in the long run. As already mentioned, this is not yet a best
practice, but a concept in the development/testing phase.

3.3.2.4 Output of a Company Valuation

In the context of a holistic company valuation, investment banks or M&A boutiques
always resort to a valuation package, since various valuation procedures usually take
into account different information and thus deliver different company values. The
output of each valuation method is not a single value but, as mentioned before, a
range. In case of multiples, for example, a multiplier of +/ 10% is applied to the
calculated enterprise value. In a DCF analysis, a sensitivity analysis is performed at
the end of the calculation and a check is made as to which enterprise value would
result, for example, from a different WACC or a different perpetual growth rate. The
specification of a company value range and not a concrete company value takes
account of the fact that, on one hand, the valuation methods are based on
assumptions and, on the other hand, the comparable companies do not correspond
100% to the company to be valued. It is therefore a kind of risk buffer. The following
figure (own representation based on Mohr & Bärtl, 2012, p. 266) shows how the
exemplary result of a company valuation looks like in practice (Fig. 3.5).

3.3.2.5 Differences in Business Valuation for Medium-sized Companies

and Large Companies
The superordinate process of a company valuation, to determine a company value
range, is approximately the same for both a medium-sized and a large target
company. As a rule, the individual valuation procedures usually follow an interna-
tionally comparable approach. If, on the other hand, one looks at the detailed level of
the valuation procedures, clear differences can be seen between a company valuation
for a mid-cap and one for a large-cap company.
Large-cap companies are often listed companies. These have the advantage that
the current fair market value of the company can be derived relatively easily from the
share price, which prices in all information from all market participants.
Additionally, an investment bank or M&A boutique can often perform a textbook
DCF valuation for a large company (Hackspiel, 2010, p. 131). This is because
detailed company reports (e.g., annual financial statements, quarterly reports, budget
figures, etc.), as well as analyst reports on the target company, are often available.
This means that the plausibility of the accessible information (incl. planning data)
can be easily understood and checked, and a well-founded DCF valuation can
subsequently be implemented.
The implementation of a multiples valuation is also relatively straightforward in
the case of large target companies. On one hand, a peer group of listed companies
(quick comps) can be created in a very short time using qualified databases, which
must then of course be checked for their actual strategic fit. On the other hand, it is
often not necessary to apply large premiums or discounts to the multiples
84 3 M&A Sales Process

Enterprise Value (EURm)

DCF analysis:
WACC: 10% perpetual growth rate: 1.5% 70 77

Comparable companies analysis:

EV/EBITDA: 6.20x EBITDA 2022E: 10 EURm 56 68

EV/EBIT: 9.76x EBIT 2022E: 5 EURm 44 54

Comparable transactions analysis:

EV/EBITDA: 7.63x EBITDA 2022E: 10 EURm 69 84

EV/EBIT: 11.08x EBIT 2022E: 5 EURm 50 61

0 20 40 60 80 100

Fig. 3.5 Summarized representation of a company valuation (excl. LBO analysis)

determined, as the large company to be valued is often similar to listed peer

companies in terms of fungibility, diversification, management depth, etc.
A closer look at valuation methods reveals a different picture for medium-sized
target companies. As these are generally not listed on the stock exchange, the current
fair market value of the company cannot easily be determined by simply multiplying
the current stock market price by the number of shares.
Besides, the DCF valuation of a medium-sized target company requires the M&A
advisor to take into account many special features. As already mentioned in the
previous chapters, the valuation-relevant data of many smaller medium-sized
companies must first be prepared by the investment bank or M&A boutique.
Often, due to reduced auditing duties, e.g., annual financial statements have to be
checked for accounting errors or manipulations and necessary items in the income
statement have to be adjusted. Many companies in the lower SME segment also
regularly do without longer-term corporate planning. In most cases, only rudimen-
tary sales and expense plans are available for a short-term period of no more than
3 years. There is usually no forward-looking planning of the balance sheet or cash
flows. In many cases, the M&A advisor of a medium-sized target company must
therefore develop plausible planning figures in intensive and time-consuming coop-
eration with the managing director or management of the medium-sized company,
which forms the basis of a future-oriented DCF valuation (Hackspiel, 2010,
pp. 131–133).
Finally, specific characteristics of regularly family-run SMEs must be taken into
account for valuation. Some of these specifics are listed below (Müller, 2011,
pp. 28–29):

• A high degree of person-centeredness

• A lower degree of diversification
• Smaller company size
• (Cluster) risk in customer or supplier portfolio
• Lack of liquidity (or lack of fungibility)
• Control influence of the entrepreneur(s)
3.3 Phase III: Examination of Financial Aspects 85

This results in certain risk premiums or discounts, which often have an impact on
the enterprise value of a medium-sized target company to be determined in the
context of a DCF valuation, e.g., in the form of an increased or decreased discount
rate for free cash flows.
Similarly, in a multiples valuation for a medium-sized company, an adjustment
factor is applied to the multiples calculated in each case due to certain risk premiums
or discounts (e.g., EV/EBITDA ¼ 10.00x and adjustment factor ¼ 0.9 ! Adjusted
EV/EBITDA ¼ 9.00x). In this way, the specific differences between a medium-sized
company to be valued and a much larger listed peer group companies are to be taken
into account. Typical discounts and premiums are listed below:

• Discount for lack of fungibility

• Discount for size difference to the peer group
• Discount for person-centeredness
• Discount for lack of diversification
• Discount for lack of management depth
• Premium for control influence
• Premium for profitability
• Premium for vertical integration

Finally, the application of the multiplier method must be critically questioned in

case of companies from the lower mid-market segment, which may still be in the
start-up phase. In this case, the target company has often not yet developed its full
potential and the future earnings power is not sufficiently taken into account in the
multiples.

3.3.2.6 Checklists: Company Valuation, Discounted Cash Flow Method

and Multiples Method

Important
Checklist: Company valuation
• Company valuations play a decisive role in the pricing process of an M&A
transaction.
• It consists of the market value of the company’s equity (Equity Value) and
the net financial liabilities of the company.
• M&A consultants always use several valuation methods in the course of a
company valuation (valuation package).
• There is no such thing as a universal enterprise value for a particular target
company at a specific point in time does not exist.
• The result of a company valuation is always a company value range, which
serves as a basis for decision-making.
86 3 M&A Sales Process

Important
Checklist: Discounted Cash Flow Method

• DCF methods derive the enterprise value to be determined from the future
earning power of the target company.
• The enterprise value corresponds to sum of the expected future cash flows
of the company discounted to the valuation date.
• In principle, a distinction is made between three DCF approaches:
1. WACC approach
The future cash surpluses to which both equity and debt providers are
entitled are determined and discounted using the WACC. The
result is the total value of the company.
2. Adjusted present value (APV) approach
In the APV approach, as in the WACC approach, the total value of
the company is first determined. However, in contrast to the
WACC approach, a notionally unleveraged company is assumed
and the tax shield is considered in isolation.
3. Equity approach (net approach)
Future cash surpluses are determined and discounted at the cost of
equity, which is attributable exclusively to the equity providers.
The result is the direct market value of the company’s equity.
• Advantages of DCF methods:
(a) Future orientation
(b) Adjustment for one-time events
• Disadvantages of DCF methods:
(a) Company value is strongly based on assumptions made
(b) Uncertainty with regard to the future forecasts made
(c) Higher time expenditure and technical complexity

Important
Checklist: Multiples methods

• The assumption of the multiples methods is that similar companies are also
valued similarly.
• In multiples methods, the sought-after value of the company to be valued is
determined using multiples derived from the known market values of other
listed comparable companies or past M&A transactions.
• Equity value vs. enterprise value multiples:

(continued)
3.3 Phase III: Examination of Financial Aspects 87

(a) Equity value multiples ¼ equity value/reference value after interest

(b) Enterprise value multiple ¼ enterprise value/reference value before
interest and taxes
• Basically, a distinction is made between two multiples methods:
1. Trading multiples method
How much would the company to be valued be worth on the stock
market today if it were compared with similar listed companies?
2. Transaction multiples method
On the basis of comparable transactions already carried out in the
past, how much would the company to be valued be paid approxi-
mately today?
• Advantages of multiples methods:
(a) Market serves as a valuation benchmark
(b) Fast and simple calculation of the multipliers
• Disadvantages of the multiples methods:
(a) Multiples are influenced by current market situation
(b) Multiples are based on past values

3.3.3 Structuring of the Transaction

Both seller and buyer aim to structure a transaction to maximize their respective
shareholder value. As a result, the interests of these two parties may diverge.
Sustainable transaction success can only be achieved through a sensible combination
of the key features of the structuring process. In this context, the features are
interdependent, so that a change in one feature can lead to complications for one
or more others (Ernst & Häcker, 2011, pp. 53–54).

3.3.3.1 Overriding Features of Transaction Structuring

The main characteristics of a transaction structuring are:

• Form of acquisition
• Acquisition vehicle
• Post-merger structuring
• Mode of payment
• Tax structuring

The form of acquisition describes the procedure by which the assets or shares are
transferred from the target company to the buyer. Although there are a variety of
ways to do this, the following forms are distinguished (Ernst & Häcker, 2011, p. 54):
88 3 M&A Sales Process

• Purchase of assets
• Share purchase
• Share swap
• Shares for assets
• Merger

The most common acquisition vehicles include:

• Incorporated companies
• Investment companies
• Partnerships (joint ventures)

Each of these acquisition vehicles involves different risks and tax consequences
for the buyer.
The form of the company after the completion of the transaction is significantly
related to the strategic orientation of the buyer. Especially if the buyer wants to
incorporate the target company as soon as possible.
The most common payment methods are payment in cash, payment with shares,
and payment with credit instruments. The payment with shares is more complicated
than cash payment and also involves the risk of price declines in the period after the
transaction. Payment with credit instruments can be lucrative for both the buyer and
the seller. The buyer can benefit from tax-deductibility of interest on borrowings,
while the seller can profit by exercising convertible bonds. However, tax aspects
should by no means be the decisive criterion in transaction structuring.
Structuring a transaction is a highly complex task that has to be mastered in the
course of an M&A process. It must always be tailored to specific features and
challenges of the transaction in question.

3.3.3.2 Checklist: Ten Guiding Principles for Successful Transaction

Structuring

Important
Checklist: Ten guiding principles for successful transaction structuring (Ernst
& Häcker, 2011, pp. 55–56)
1. Guiding principle 1: Legal structure
Legal structuring should promote the transaction objectives being
pursued.
2. Guiding principle 2: Tax structuring
The tax structuring should contribute to a minimization of the tax expense
incurred.
3. Guiding principle 3: Accounting principles

(continued)
3.3 Phase III: Examination of Financial Aspects 89

In international transactions, different accounting principles (e.g., IFRS,

US-GAAP) must be observed.
4. Guiding principle 4: Country-specific aspects
Intercultural differences must be taken into account as part of transaction
structuring.
5. Guiding principle 5: Organizational structure
Post-merger integration should already be considered in the structuring
phase.
6. Guiding principle 6: Shareholders’ interests
Shareholders’ interests (maximizing returns) should be considered.
7. Guiding principle 7: Minority and majority interests
It should be noted that the party holding a majority directs the
proceedings.
8. Guiding Principle 8: Listed or unlisted company.
The acquisition of a listed company increases the complexity of the
transaction.
9. Guiding Principle 9: Financial investors or strategic investors
Financial investors pursue short-term goals, while strategic investors
pursue long-term goals.
10. Guiding Principle 10: Acquisition financing
Acquisition financing determines the overall transaction structure and
determines the financial feasibility of the transaction.

3.3.3.3 Acquisition Financing

If production is the father of success, then financing is its mother (Nüsser, 2010,
p. 171). In analogy to this quote, in addition to the realization of synergy potential
and certain strategic goals, financing tailored to the individual characteristics of a
specific corporate transaction represents a key success criterion in the context of an
M&A transaction.
The successful acquisition of a company or parts of a company always depends
on the availability of the financing funds intended for this purpose. In daily practice,
numerous corporate transactions fail despite an amicable purchase price agreement
between the seller and buyer because no financing commitment is given by a bank or
banking group for an intended corporate acquisition (e.g., during the low phase of
the recent financial market crisis). For this very reason, solid acquisition financing is
an essential piece of the puzzle in the entire M&A process, not only for the buyer but
also for the seller.

" Definition The term acquisition financing stands for the financing of the acqui-
sition of a company, part of a company, or a group of companies. As a rule, a buyer
90 3 M&A Sales Process

will use a combination of equity and debt instruments. Acquisition financing is

generally cash flow-oriented.

The respective ratio between equity and debt often ranges between 50/50 and
30/70. As the proportion of debt increases, the aim is to benefit from the leverage
effect. This describes the leverage effect of a growing debt ratio in the improvement
of the return on equity if the interest on borrowed capital is below the internal rate of
return. If acquisition financing is characterized by a high proportion of debt, it is
referred to as a leveraged buy-out. Furthermore, acquisition financing for a large
target company is rarely provided by a loan from a single bank, but usually by a
syndicated loan from a consortium of banks (Ernst & Häcker, 2011, pp. 169–170).
The leveraged buy-outs already mentioned are often preferred and carried out by
financial investors as the buyer type. In this way, the return on equity can be
significantly increased with a lower equity investment and a positive leverage effect.
However, as LBOs only account for a small proportion of all M&A transactions
worldwide (although the trend is rising), the main focus of the following comments
on acquisition financing will be on corporate buy-outs (CBOs).

Challenges in Acquisition Financing

Acquisition financing regularly leads to a significant increase in leverage ratio of the
borrower. The diverging goals of the parties involved—equity and debt investors—
result in a conflict of objectives. On one hand, equity investors aim for the highest
possible debt ratio to reduce their liability risk and benefit from the leverage effect.
On the other hand, providers of debt capital demand a high equity ratio in the
financing to keep their credit risk as low as possible (Rodde, 2012, p. 325).
The personal liability of the buyer is usually minimized by setting up a single-
purpose company, also known as a special purpose company (SPC) or NewCo,
which is used by the buyer solely to acquire the target company. Under this
configuration, the personal liability of the buyer is limited to the equity contribution
made to the NewCo. As a result of this structuring, the collateral for a financing bank
is significantly limited, which means that the cash flow of the target company plays a
decisive role. Thus, acquisition financing is a cash flow-oriented form of financing
(Ernst & Häcker, 2011, pp. 170–171).

Goals of Capital Providers

As mentioned above, there is a conflict of objectives between the interests of equity
providers and those of debt providers. Both parties want to keep their share of
financing volume of the acquisition as low as possible to minimize their risk.

Equity Investors
The main objectives of equity investors (financial investors) include (Ernst &
Häcker, 2011, pp. 181–182):

• High profitability or high internal rate of return (IRR): The return on equity is to
be maximized as far as possible using a low equity ratio and a high debt ratio by
3.3 Phase III: Examination of Financial Aspects 91

exploiting the leverage effect. The debt financing ratio is limited by the target
company’s maximum debt-servicing capacity.
• Limited liability: An equity investor seeks to limit its personal liability to equity
contributed to the single-purpose entity (NewCo). In this process, the NewCo
acquires the shares in the target company, pays the purchase price to the seller,
and acts as a borrower in acquisition financing.
• High degree of contractual flexibility: The equity investor endeavors to structure
the financing in such a way as to give him the greatest possible degree of
flexibility regarding the structure of the loan agreement (e.g., flexibility in
drawing down the loan, minimization of collateral to be provided, etc.).
• Low cost: An equity investor wants to minimize the cost of drawing down the
debt capital as low as possible. The costs consist of loan origination fees and
ongoing interest payments.

How successfully an equity investor’s goals can be realized depends on the

amount of the purchase price, the ability to negotiate with financing banks, and
planning security and continuity of the target company’s cash flows.

Debt Capital Providers

The most important objectives from the perspective of debt capital providers are
listed below (Ernst & Häcker, 2011, pp. 178–180):

• Low debt financing ratio: A low debt financing ratio and an appropriately high
equity ratio in acquisition financing should minimize the credit risk of the debt
provider.
• Loan collateral: Equity investors often minimize their personal liability by
establishing a single-purpose entity that is used to acquire the target company.
To ensure that a debt investor can still minimize credit risk, it requires extensive
loan collateral from the buyer that relates to both the target company and the
equity investor.
• Loan syndication in the market: Often, due to financing volume of an acquisition
financing, a syndicated loan is agreed between several banks and the buyer. This
group of banks will subsequently seek to sell parts of the debt financing to other
banks in order to reduce their own credit risk. In order to guarantee divestment or
syndication capability, care must be taken when structuring the acquisition
financing to ensure that loan terms are in line with market conditions.
• High return: Lenders, like equity investors, pursue the goal of achieving the
highest possible return via the facility fees and ongoing interest payments from
the acquisition loan.

The successful realization of a lender’s objectives depends to a large extent on the

future cash flows of the target company and the competitive pressure among
acquisition-financing banks.
92 3 M&A Sales Process

General Conditions for Acquisition Financing in Corporate Buyouts

Analogous to the choices regarding the structure of an M&A transaction, acquisition
financing can be structured in several ways and adapted to the individual
requirements of the underlying acquisition.

Sources of Financing for the Purchase Price

In general, the purchase price for a company acquisition can be financed through
three different sources (Mittendorfer, 2007, p. 11):

1. from free liquidity of the buyer

2. through new equity and/or debt capital of the purchaser
3. via an acquisition company that services the debt capital to acquire the company
by accessing free cash flows of the company being sold

In practice, the purchase price is often paid via a combination of these financing
sources.

Transaction Volume
In acquisition financing, the transaction volume is generally financed by liable equity
and debt. In cases where the contributed equity and the available debt do not cover
the total transaction costs and thus a financing gap arises, hybrid forms of
financing—e.g., mezzanine capital—are often used.
NewCo and the target company need the funding for several purposes (Ernst &
Häcker, 2011, p. 203):

• The lion’s share of the funding is required by NewCo to finance the purchase
price for the acquisition of the target company.
• The target company requires funds to repay existing liabilities to previous banks
and former owners (shareholder loans).
• The transaction costs, which include due diligence costs and consulting fees, for
example, must be financed. They are often in the range of 3.5% to 5.0% of the
purchase price.

In the context of acquisition financing, all existing bank liabilities of the target
company are usually repaid and replaced by bank loans from acquisition-financing
bank(s). This procedure is based on the principle of full financing. This is intended to
ensure that the target company is fully integrated into the acquisition financing
through loan agreements that govern the target company’s obligations (Ernst &
Häcker, 2011, pp. 200–201).

Direct and Indirect Acquisition

Two types of structures of corporate buy-outs can be distinguished:

• Direct acquisition
• Indirect acquisition
3.3 Phase III: Examination of Financial Aspects 93

In case of a direct acquisition, the shares in the target company are acquired
directly by the strategic buyer itself (see Fig. 3.6). The strategic investor pays the
purchase price to the former owners of the target company and in return receives
their shares in the target company. Subsequently, the target company is often
integrated as a subsidiary in the corporate group of the buyer or merged with the
buyer company (Kohabe & Hirdes, 2011, p. 553).
In practice, the majority of acquisition financing takes place in the form of
on-balance financing in case of the purchase of a corporate target by a strategic
investor. On-balance financing has the advantage for the acquirer that, in contrast to
off-balance financing, the target must be continued as an independent stand-alone
company, synergy effects from the corporate acquisition can be realized directly.
Company acquisitions by a strategic investor usually aim to realize sales and cost
synergies. In this respect, acquirers usually prefer on-balance financing.
On-balance sheet financing presents the bank financing the acquisition bank with
greater tasks than off-balance financing. In on-balance financing, two due diligences
must be carried out and evaluated, one for the buyer and one for the company to be
purchased. Not only do the two companies need to be analyzed separately, but the
question of how the overall engagement will develop after the acquisition needs to
be answered. If the buyer and the company to be acquired both have investment
grade, on-balance financing is normally not a problem for the acquisition-financing
bank. In this case, the entire financing is assigned to the target company. The target’s
assets are then often sufficient as collateral, and occasionally the financing is
provided without collateral.
The situation is much more complex if the company to be acquired or both
companies—the target and the buyer—are non-investment grade. In this case, the
acquisition-financing bank has to perform a detailed consolidated analysis of the
cash flows of the buyer, the target, and the companies as part of the financial
modeling process. This is the only way to check whether the acquisition financing
is presentable for the bank or not.

Shareholders of the
buyer company

Purchase price
payment Acquisition loan
Former owners of
Buyer company Bank
the target company
Transfer of shares Repayment of the
or assets acquisition loan
Acquires
the shares Free Cash
or assets Flows

Target company

Fig. 3.6 Simplified acquisition structure for a direct acquisition with liability recourse to the buyer
94 3 M&A Sales Process

In a direct acquisition, the strategic investor uses its unused debt capacity as well
as its own future free cash flows and the future FCFs of the target company to service
the debt resulting from the acquisition financing. The buyer acts directly as a
borrower of the acquisition loan vis-à-vis the financing bank and handles the
acquisition financing directly via its balance sheet. In this constellation, the lenders
have recourse to both the target company and the buyer company as a liability mass
in the event of an emergency (Mittendorfer, 2007, p. 37) (Kohabe & Hirdes, 2011,
p. 553).
In addition to strategic investors, indirect acquisition is mainly used by financial
investors in the context of a leveraged buy-out and is therefore often referred to as a
typical LBO purchase technique. As a rule, it is carried out in the following five steps
(Ernst & Häcker, 2011, pp. 196–198) (Kohabe & Hirdes, 2011, p. 553)
(Mittendorfer, 2007, pp. 37–38):

1. Formation of a single-purpose company: In the first step, the strategic investor

establishes a single-purpose company, often referred to as NewCo (New Com-
pany), SPV (Special Purpose Vehicle), or SPC (Special Purpose Company). The
sole purpose of this NewCo is to acquire the target company. Thus, the single-
purpose company itself does not conduct any operational business. The legal
form frequently chosen for the SPV is GmbH or GmbH & Co. KG is often chosen
as the legal form of the SPV to limit the personal liability of the buyer to the
equity contribution to NewCo. This form of financing, which excludes any
recourse to the buying company, is known in specialist circles as non-recourse
financing (see Fig. 3.7, own representation based on Mittendorfer, 2007, p. 87).
As part of the evaluation of the acquisition financing by the bank(s), future free
cash flows of the target company for servicing the debt in this non-recourse
configuration are particularly important.
2. Providing the single-purpose entity with financial resources: In the second step,
NewCo is provided with equity by the strategic investor and with acquisition loan
by the financing bank. The total capital contributed to the single-purpose entity
covers the transaction costs—purchase price plus incidental transaction costs.
The equity contribution ideally comes from the buyer company’s petty cash or
from newly raised equity or debt capital. Due to excluded liability recourse to the
buying company, the buyer should document its commitment or its seriousness
with regards to the planned acquisition to third-party investors with an appropri-
ate equity contribution to NewCo (skin in the game).
3. Providing the target company with financial resources: In the third step, the target
company is provided with a working capital line of credit from the acquisition
financing bank. This revolving working capital loan is used to finance the target
company’s current assets (working capital).
4. Acquisition of the shares in the target company by single-purpose entity: In the
fourth step, NewCo acquires shares in the target company from the former owners
and pays them the agreed purchase price at the same time. In this situation, the
asset side of the NewCo balance sheet consists only of the investment in the target
company. The liabilities side of the NewCo balance sheet consists of equity
3.3 Phase III: Examination of Financial Aspects 95

Shareholders of the
buyer company

Buyer company

Equity capital
Non-recourse line
Purchase price
payment Acquisition loan
Former owners of
NewCo Bank
the target company
Transfer of shares Repayment of the
or assets acquisition loan
Acquires
the shares Free Cash
or assets Flows

Target company

Fig. 3.7 Simplified acquisition structure for an indirect acquisition without liability recourse
(non-recourse) to the buyer

contribution of the acquiring company and the acquisition loan taken out by the
bank(s).
5. Merger of the target company with the single-purpose entity: Often, in the final
step, the target company is merged or amalgamated with NewCo, thereby ensur-
ing the tax-deductibility of the interest payments on the acquisition loan taken out
by the NewCo.

Key benefits of an acquisition by a strategic investor in non-recourse financing

include (Mittendorfer, 2007, p. 38):

• Limitation of liability on the capital contribution made to NewCo

• Maximization of return on equity
• Ability to shape the balance sheet ratios
• Greater flexibility for partnerships and in terms of conditions

Often, the advantages mentioned outweigh the disadvantages that arise, such as
higher financing costs and narrower room for maneuver (especially due to
covenants) (Mittendorfer, 2007, p. 38).
Off-balance-sheet financing is used less frequently by strategic investors than on-
balance-sheet financing, as the separation of the target company from the buyer and
the so-called ring-fencing prevents the buyer from exploiting sales and cost
synergies. This fundamentally calls into question the sense of the acquisition.
Off-balance sheet financing is an interesting financing model for the buyer if it
considers the risk of the acquisition to be high and wishes to limit its risk to the
96 3 M&A Sales Process

capital paid into NewCo. In a worst-case scenario, the strategic investor would then
terminate the commitment without jeopardizing its core business.
For the acquisition-financing bank, off-balance-sheet financing is less costly and
complex, as the financing is based solely on the target company. If the target is in a
position to service the acquisition financing with its cash flows without any
problems, there is nothing to prevent the acquisition financing. A problem for the
acquisition-financing bank could arise if the buyer were to undermine the target
company economically by charging for services, thereby increasing the risk for the
bank compared with the scenario assumed at the beginning. A transfer of know-how
from the target company to the buyer could also be problematic. This would
significantly reduce the value of the target and significantly increase the bank’s risk.

Share Deal Versus Asset Deal

The type of transaction implementation is of great importance for the
collateralization of acquisition loans. In general, two transaction models can be
chosen for the acquisition of the target company:

• Share deal: The buyer company or the NewCo acquires the shares of the target
company from the previous owners.
• Asset deal: The buyer company or NewCo acquires the assets and parts of the
liabilities of the target company at their fair values.

The seller of a target company will generally prefer a share deal since with the
transfer of the company shares, he completely exits the company—including the
entrepreneurial responsibility and risks—and for him, the transaction is thus fully
completed. In contrast, the seller in an asset deal must liquidate the empty shell of the
company after completion of the M&A transaction, which can result in a lengthy
process.
The buyer of a target company will often prefer an asset deal because, for
example, the internal financing potential is increased by possible write-downs on
the realized hidden reserves concerning certain transferred assets. In contrast, a
buyer will evaluate a pure share deal as critical. In the event of insolvency, the
shares in the target company would be worthless, which is why the shares used as
collateral for the acquisition loans are viewed with extreme skepticism by
acquisition-financing banks.
Due to this conflict of interest, a combination of a share deal and asset deal is
often chosen in transaction practice. In a first step, a share deal is executed and the
shares in the company are transferred from the former owners to NewCo. Then, in a
second step, an asset deal is executed and the legal integration of the target company
into the corporate group of the buyer company is carried out. In this way, the assets
of the target company can be used to secure the acquisition loans and, also, the free
cash flows without tax deductibility can be used to repay the liabilities (Ernst &
Häcker, 2011, pp. 199–200) (Kohabe & Hirdes, 2011, p. 554).
3.3 Phase III: Examination of Financial Aspects 97

Assessment Basis for Acquisition Financing: Debt Service Capability

The correct determination of the ratio of debt to equity and mezzanine capital is an
essential criterion for success in acquisition financing. In contrast to the granting of
typical bank loans, valuable assets placed as collateral for the bank loan play a
subordinate role in acquisition financing. The ability to service debt, which has a
significant influence on the granting of acquisition loans, is primarily determined
through a cash flow analysis. In this context, the term structured financing is used. To
determine the debt servicing capability, the acquisition-financing banks set up
financial models (bank case or financing case) which, in case of a direct
(or indirect) acquisition, are used to determine the available cumulative free cash
flows of the target company and the acquiring company (or only the target company)
for debt repayment. The financial models are based on the balance sheet and income
statement data as well as certain assumptions made by the acquisition financing bank
(s). Since acquisition loans are long-term loans with a term of 5–9 years, in addition
to the absolute amount of cash flows for debt repayment, their stability and predict-
ability are crucially important.
In practice, the framework conditions described generally result in an acquisition
financing structure in which not only a single loan is granted to the acquiring
company (or NewCo), but the acquisition loan consists of several tranches with
different terms, repayment modalities, and conditions. The cash flow used to repay
the debt is primarily used for the repayment of senior tranches (senior loans). The
other financing instruments required for acquisition financing (e.g., mezzanine
capital) are regularly repaid at maturity after all senior tranches have been serviced.
The cash flow remaining after repayment of the senior tranches (excess cash flow)
accrues to the cash fund and can be used, for example, to finance working capital or
for investments in fixed assets. As part of the overall financing structure, it must be
ensured that the target company (and possibly the acquiring company) can manage
the debt repayment and still retain sufficient liquidity for necessary investments. This
is the only way to secure the M&A transaction and, more importantly, the going
concern (Ernst & Häcker, 2011, pp. 204–206).

Requirements for an Optimal Acquisition Structure

An optimal acquisition structure should meet the following requirements
(Mittendorfer, 2007, p. 88) (Kohabe & Hirdes, 2011, p. 564):

• The buyer often wants a limitation of liability on his equity investment.

• The transaction should be optimized for tax purposes (with regards to deductibil-
ity of interest on the buyer’s side and taxation of the sale proceeds on the
seller’s side).
• The financing structure must be viable for the buyer and the target company.
• The financing must be secure. The required funds must be available on time and
in the required amount.
• The investors must be able to expect a return commensurate with the risk.
• The acquiring company or NewCo should have easy access to the target
company’s free cash flows for servicing the acquisition loans.
98 3 M&A Sales Process

Choice of Suitable Financing Instruments

The exact composition of the financing instruments (financing mix) in an acquisition
financing is a case-by-case decision, depending on the M&A transaction, into which
specific decision-making considerations must flow. The following factors are regu-
larly taken into account in the selection of suitable financing instruments (Kohabe &
Hirdes, 2011, pp. 565–567):

• Transaction volume
• Legal form (with regard to stock exchange issues)
• Company size (with regard to stock exchange issues)
• Debt-equity ratio (indicator of potential for further borrowing)
• Collateral potential (especially with regard to borrowing)
• Liquidity situation and profitability of the target company
• Time availability of financing instruments (e.g., IPO or bond issue)
• Financing costs

Financing Instruments in the Context of Corporate Buy-outs

In practice, the transaction volume in an acquisition is predominantly provided by
liable equity and available debt capital. However, a financing gap often arises which
is closed, for example, by hybrid financing instruments. Accordingly, a financing
mix is regularly chosen to realize a planned acquisition.
In principle, a distinction can be made between internal and external financing,
irrespective of the legal form of an acquiring company.
In case of internal financing, the required funds are generated in operating
performance and sales process.
In case of internal financing, the required funds are generated in operating
performance and sales process. In contrast, in case of external financing, the required
funds are made available either from external sources of capital, e.g., in the form of
equity contributions and investments or from loans and credits (Wirtz, 2012, p. 21).
The most important financing instruments in the acquisition financing are
displayed in Fig. 3.8.

Internal Financing Instruments

The financial resources generated in the course of internal financing or the opera-
tional sales process do not come from the owners or other creditors of the company.
Rather, they are generated independently by the respective company.
Internal financing effects can be generated in several ways. Operating cash flow
can be regarded as the most important form of internal financing, which is made up,
for example, of profit, depreciation returns, or from the formation of provisions. This
form of internal financing is also referred to as self-financing. Besides, internal
financing can generate funds through asset reallocations (Kohabe & Hirdes, 2011,
p. 530).
Open and Silent Self-financing
Self-financing can in turn be subdivided into open and silent self-financing. The
most important instrument of open self-financing is the retention of profits. This
3.3 Phase III: Examination of Financial Aspects 99

Financing instruments

Internal financing instruments External financing instruments

Self- Asset Debt Hybrid financing

financing restructuring instruments instruments

Open self- Asset stripping Senior term loans Equity

financing mezzanine

Silent self- Sale-and-lease- Working capital Debt mezzanine

financing back loans

Factoring

Asset Backed
Securities

Fig. 3.8 Financing instruments used for acquisition financing

refers to the retention of profits generated by a company within a certain period and
not distributed to the shareholders. These retained profits can, for example, be used
later for the acquisition of a target company.
In case of dormant self-financing, by taking advantage of dormant self-financing,
hidden reserves is formed and the taxable profit reduced by exploiting the scope for
valuation and accounting under commercial and tax law. However, hidden self-
financing is merely a tax deferral effect, which initially conserves cash flow but does
not permanently leave the realized financial resources to the company (Wirtz, 2012,
p. 175) (Kohabe & Hirdes, 2011, pp. 530–531).
Asset Reallocations
In addition to self-financing, asset reallocations can also prove to be an effective
means of creating liquidity. The most common instruments used in asset
restructuring include (Mittendorfer, 2007, pp. 166–168) (Kohabe & Hirdes, 2011,
pp. 531–533) (Müller, 2010, p. 184):

• Asset stripping: Asset stripping is the sale of assets that are not required for
operations, e.g., unused real estate or decommissioned machinery. Through this
targeted disinvestment, previously tied-up capital can be converted back into
liquidity and used for the acquisition project. In addition, asset stripping often
allows hidden reserves in the company to be leveraged. This is the case when the
selling price of the respective asset is higher than its book value.
• Sale-and-lease-back: In contrast to asset stripping, in sale-and-lease-back process
certain parts of the (fixed) assets required for operations are sold to a third
company (often a special leasing company) to subsequently lease them back to
100 3 M&A Sales Process

the company itself. In this way, hidden reserves can often be leveraged within the
company.
• Factoring: Factoring is the sale of trade accounts receivable of the company’s
trade receivables from third-party debtors to a so-called factoring company. This
allows liquidity to be generated directly.
• Asset-backed securities: Asset-backed securities (ABS) are securities or promis-
sory bills that guarantee payment claims against a special purpose vehicle (SPV)
set up specifically for the ABS transaction. A company’s receivables are trans-
ferred to this single-purpose entity to create liquidity. The SPV then refinances the
receivables on the capital market by issuing securities backed by assets.

Finally, when acquiring a target company, internal financing can be applied by

both the buyer and the target company. The liquidity thus gained can then be
contributed to the financing structure as supplementary equity or used for debt
service (Kohabe & Hirdes, 2011, p. 533).

External Financing Instruments

In most cases, a buyer company’s internal financing potential and existing petty cash
are not sufficient for acquisition financing. Instead, external financing instruments,
i.e., funds that do not come from the company itself but are provided from outside
via the capital or credit market, are used (Wirtz, 2012, p. 288).
The spectrum of external financing instruments ranges from equity to debt and
hybrid financing instruments. Due to the importance of certain financing elements
with regard to corporate buyouts, the focus below is on debt and mezzanine capital
instruments.
Debt Financing Instruments
In case of acquisition financing, debt capital or debt financing instruments play a
decisive role in acquisition financing. The cost of capital for borrowing is lower than
the cost of capital for equity, among other things because the capital is provided for a
limited period and the lenders are not liable. Furthermore, borrowing is preferred for
acquisition financing because, under certain conditions, a positive leverage effect
can be profited from as debt increases and, in addition, the interest on the loan is
tax-deductible. In general, it can be said that the provision of debt capital continues
to dominate the financing structures encountered in corporate acquisitions (Kohabe
& Hirdes, 2011, p. 557).
The following two debt financing instruments are regularly encountered in the
context of acquisition financing:

• Senior term loans

• Working capital loan (revolving credit facility)

Senior Term Loans

The debt raised for acquisition financing is mainly composed of senior term loans of
various tranches (A, B, C, D, etc. tranches). Senior term loans are considered to be
financing instruments with the lowest risk of default in acquisition financing, as they
3.3 Phase III: Examination of Financial Aspects 101

are generally well collateralized and are repaid in priority to all other financing
instruments in an event of liquidation, e.g., due to insolvency. Senior term loans are
long-term financing instruments with typical maturities of between 5 and 9 years,
which are repaid according to a precisely defined repayment schedule defined in
advance (Ernst & Häcker, 2011, p. 214).
A senior term loan is often provided to the borrower in multiple tranches (Ernst &
Häcker, 2011, pp. 209–211):

• Senior A tranche: This is a repayment loan with 6-month or 2-month repayment

dates. This loan is therefore repaid in equal installments over its term. Compared
with the other senior tranches, the senior A tranche has the shortest repayment
term, usually not exceeding 7 years.
• Senior B tranche: The senior B tranche is not repaid until the A tranche has been
repaid in full. With this tranche, the loan amount is often repaid in a single
payment at the end of the term (bullet repayment). The term of a senior B tranche
is usually 1 year longer than that of a senior A tranche. Due to longer-term and
bullet repayment, the borrowing costs of a senior B tranche are higher than those
of an A tranche.
• Senior C tranche: Similar to B tranches, senior C tranches are bullet loans with a
credit period 1 year longer than B tranches. As a result, they are repaid after the B
tranches and therefore carry a higher interest rate.
• Senior D- etc. tranches: These are also bullet loans, each with a term 1 year longer
than the preceding senior tranche and with an increasing interest rate as the loan
term increases.

Working Capital Loan

A working capital loan is intended to ensure that the target company has sufficient
liquidity to finance its current assets (working capital). On a contractual basis, it may
only be used for this purpose and not, for example, for investments in the target
company’s fixed assets (capex). The inventories and trade receivables of the target
company are regularly used as collateral for a working capital loan.
With a view to acquisition structuring, the target company’s existing working
capital lines of the target company are completed by a working capital loan from the
acquisition-financing banks. In this way, a conflict of objectives between the existing
financing banks and the acquisition-financing banks is to be circumvented and
complete control over the target company is to be achieved. The new working
capital loan has the same term as the senior term loan to ensure the integrity of the
acquisition financing. Furthermore, the working capital credit line is normally
revolving, i.e., it can be drawn down by the target company regularly (Kohabe &
Hirdes, 2011, p. 559). To ensure that the working capital line is used to finance
current assets and not, for example, for long-term investments in fixed assets, full
repayment of the working capital loan (clean down) is generally contractually agreed
upon once a year. After the working capital loan has been repaid, it can be drawn
down again by the target company (revolving working capital line) (Ernst & Häcker,
2011, pp. 212–214).
102 3 M&A Sales Process

Hybrid Financing Instruments (Mezzanine)

Mezzanine capital is one of the hybrid financing instruments and can be classified
between equity and debt capital. Mezzanine instruments can be structured in a wide
variety of ways, which is why mezzanine capital is regarded as a highly flexible
financing instrument. Despite the great freedom of design, most mezzanine
instruments combine the following characteristics (Ernst & Häcker, 2011, p. 215):

• Subordination to debt capital and priority to equity capital (with regards to

collateralization and ranking in the event of insolvency)
• No say for mezzanine capital providers
• Limited credit period, usually between 5 and 10 years
• Tax-deductibility of interest payments as operating expenses
• Higher remuneration than for debt capital and lower remuneration than for equity
capital

In acquisition financing, mezzanine capital serves the purpose of closing the

financing gap after taking into account contributed equity and available debt capital.
As a rule, mezzanine capital is always used if (Mittendorfer, 2007, p. 148):

• Additional funds are to be/need to be drawn down outside the available senior
loan volume (e.g., to overcome financing gaps due to diverging purchase price
expectations of the buyer and seller)
• There is still sufficient cash flow potential for an additional layer of capital that
can be used in the coming years to service the interest liabilities
• There is an attractive and realizable potential for value enhancement in the
company
• There is no (significant) dilution of equity
• In general, no (significant) co-determination by external capital providers in the
company should take place.

Thanks to the high flexibility of mezzanine capital, the financing arrangements

can be adapted in the best possible way to the specific conditions of a corporate
acquisition. This is demonstrated, among other things, by special repayment or
redemption modalities of the mezzanine capital. The ongoing financing costs can
be reduced, for example, by agreeing to an equity kicker or non-equity kicker, thus
conserving the company’s cash flow (Kohabe & Hirdes, 2011, pp. 542–543, 560).
Depending on how it is structured, mezzanine capital is referred to either as equity
mezzanine (or junior mezzanine) or as debt mezzanine (or senior mezzanine)
(Kohabe & Hirdes, 2011, p. 540). Table 3.10 (own representation based on Ernst
& Häcker, 2011, p. 225) shows the classification of the most important mezzanine
financing instruments to equity mezzanine and debt mezzanine.
Specific mezzanine financing instruments are described in more detail below due
to their importance in acquisition financing.
3.3 Phase III: Examination of Financial Aspects 103

Table 3.10 Equity mezzanine and debt mezzanine instruments

Equity mezzanine instruments Debt mezzanine instruments
• Preferred shares • Subordinated loans
• Shareholder loans • Typical silent partnerships
• Typical silent partnerships • Participatory loans
• Convertible bonds • Profit participation certificates
• Bonds with warrants • Vendor loans
• Earn-out financing
• High yield bonds

Shareholder Loan
A shareholder loan is essentially a normal loan. It is normally agreed with a long-
term and a current interest rate. In contrast to a regular bank loan, however, the
capital for a shareholder loan is not provided by new capital providers from outside,
but from within the shareholder group. In addition, shareholder loans generally lead
to an improvement in debt financing potential due to their equity-like treatment. The
reason for this is the structural subordination of the claims of shareholder lenders to
those of debt providers in an event of insolvency (Kohabe & Hirdes, 2011,
pp. 549–550).
Vendor Loan
The vendor loan (or seller note) is an option for bridging diverging purchase price
expectations between the buyer and seller. In this case, part of the purchase price is
converted into a loan. The seller thus changes from shareholder to lender and grants a
(usually subordinated) loan to the buyer of the target company. As a result, part of
the purchase price is deferred and the transaction volume to be financed directly
(at the time of closing) is thus reduced. The term of a vendor loan is usually between
1 and 3 years (Kohabe & Hirdes, 2011, p. 551). Due to the frequently agreed
subordination of the seller behind all other interest-bearing debt claims in the
event of insolvency, a vendor loan is often regarded as (economic) equity in the
structuring. A vendor loan is also often issued without underlying collateral.
Depending on its structure, a vendor loan is repaid in several installments or as a
one-off payment at the end of the term, giving the buyer a certain amount of financial
leeway in terms of acquisition financing (Müller, 2010, p. 192) (Mittendorfer, 2007,
p. 138).
Earn-out Financing
In case of earn-out financing, the purchase price to be paid by the buyer to the seller
comprises a fixed purchase price component and a performance-related (variable)
purchase price component (earn-out). A fixed purchase price component is paid
directly to the seller at the time of closing of the sale transaction and a variable
purchase price component is paid in the coming years in the form of mostly annual
payments depending on the economic performance of the target company. Through
the variable purchase price component, the seller thus continues to participate in
future economic development of the target company for a fixed period (Mittendorfer,
2007, p. 139) (Kohabe & Hirdes, 2011, p. 552).
104 3 M&A Sales Process

Earn-out financing is typically used in the following situations (Mittendorfer,

2007, p. 139) (Kohabe & Hirdes, 2011, p. 552):

• Earn-out financing can act as a bridging tool for differing purchase price
expectations of the buyer and seller.
• In case of the sale of a family business (life’s work), an earn-out financing can
reduce the seller’s psychological inhibition threshold with regards to the transac-
tion (due to his strong attachment to the target company) using his successive
withdrawal from the company.
• An earn-out also makes sense if the seller(s) hold(s) a central management
position(s) in the target company at the time of the company sale. In this situation,
it may make sense to keep the seller(s) in the target company as active managers
for a certain period until the planned new management has been incorporated.
Thus, the seller(s) still have skin in the game and will continue to manage the
company in the best possible way for the near future.
• Lastly, earn-out financing appears to be useful in overcoming valuation
uncertainties (e.g., the target company is in a crisis; target company has had
highly volatile earnings in the near past; seller justifies high asking price largely
by planning or future the planning or future development of the company) as a
sensible financing alternative.

High Yield Bonds

As transaction and financing volumes increase, the importance of capital market
financing instruments such as corporate bonds are growing in the context of acquisi-
tion financing. In this way, significantly larger volumes can often be financed rather
than via free cash flow or the available credit facilities (Wirtz, 2012, p. 290).
From a legal point of view, corporate bonds are debt securities and generally an
instrument for long-term debt capital procurement via the capital market. The
issuance (issue) of a corporate bond can take place either via a designated stock
exchange or via a private placement. Due to high structuring, placement, and
ongoing listing costs, the stock exchange issue of a corporate bond generally
makes economic sense from an issue volume of around EUR 25 million and is
therefore reserved for large companies. The off-market issue (private placement), on
the other hand, can already be carried out with a single-digit issue volume from an
economic point of view (Kohabe & Hirdes, 2011, p. 539).
In general, the issuance of a corporate bond requires the company’s capital
market viability (e.g., interesting equity story, strong competitive position, stable
and healthy earnings situation, appropriate debt/equity ratio, etc.) and an external
credit rating of the company by a rating agency (e.g., Standard & Poor’s, Moodys,
Fitch, etc.) (Rodde, 2012, p. 330).
As corporate bonds are structured as subordinated bonds and carry a higher
interest rate in accordance with the risk, they are referred to as high-yield bonds.
They are used to finance corporate acquisitions with high transaction volumes. The
minimum issue volume of high yield bonds is around EUR 150 million. Due to their
regular maturity of 8–12 years, high yield bonds are a useful source of capital for
3.3 Phase III: Examination of Financial Aspects 105

corporate buyouts with high capital requirements, as their maturity correlates with
the long-term investment horizon of a strategic investor (Mittendorfer, 2007, p. 155)
(Rodde, 2012, p. 330).

Procedure of Acquisition Financing

The concrete course of an acquisition financing depends on the complexity of the
planned M&A transaction, the quality of the transaction preparation, and the experi-
ence of the parties involved (including the advisors) (Mittendorfer, 2007, p. 177). In
general, a viable financing concept should be drawn up as early as possible in the
course of an M&A transaction, as an optimal financing structure forms the basis for a
successful acquisition (Kohabe & Hirdes, 2011, p. 561).
From an overarching perspective, the process of acquisition financing can typi-
cally be divided into two phases:

1. Analysis before transaction closing

2. Analysis after the conclusion of the transaction

The analysis before the closing of the transaction can, in turn, be broken down
into five regularly encountered steps (Ernst & Häcker, 2011, p. 243) (Rodde, 2012,
pp. 338–339):

1. Analysis of the business plan

After an M&A transaction has been implemented by a seller or buyer and the
M&A process has progressed beyond contacting and exchanging confidential
information (e.g., information memorandum), the prospective buyer presents
the target company’s business plan (management case) to a few selected
outside investors. They then provide an initial assessment of the financial
viability of the planned transaction. The business plan should cover at least
the next three fiscal years and include information on the balance sheet,
income statement, and cash flow statement.
2. Due diligence phase
The next step is due diligence. The focus of the analysis here is to examine the
business plan of the target company (management case) before the competitive
situation of the target company. Above all, the plausibility in regards to
planning and assumptions made is examined or checked. External due dili-
gence is carried out by specialized consultants, which corresponds to
explanations from the previous chapter “Examination of financial aspects in
the M&A process.” In addition, internal due diligence is carried out by
acquisition-financing banks, which is aimed at the lending decision.
3. Revised business plan
Based on the results of due diligence, a revised business plan for the target
company is prepared in the third step using computer-based financial models.
The aim is to determine the most probable scenario possible, which forms the
basis for the company valuation and price indication. The revised business
plan forms the starting point for the financing structure (financing case). The
106 3 M&A Sales Process

Financing Case focuses on determining free cash flow that can be used to
service the debt resulting from acquisition financing.
4. Financing case and financing structure
In the fourth step, the definitive financing structure (including the amount of
funds from equity, mezzanine, and debt capital providers) is derived from the
financing case.
5. Signing and closing
Finally, the loan agreement and other contracts (e.g., purchase agreement) is
signed (signing) and, after obtaining further approvals, the purchase price is
paid and the authority to perform is transferred from the seller to the buyer
(closing).

The post-transaction analysis consists of one main activity: monitoring. Monitor-

ing is the ongoing analysis of credit risk by the acquisition-financing banks after the
transaction has been completed. It is essential in the context of acquisition financing
because acquisition financing has a significantly higher credit risk than normal
corporate loans due to its cash flow orientation. For the borrower, this regularly
results in significantly higher and stricter information obligations during the term of
the acquisition loan. Financial covenants, which are recorded and defined in the
credit agreement, are used as indicators or control instruments for the development
of credit risk. For agreed financial covenants, a minimum and a maximum value are
set for each financial quarter. If these interval limits for financial covenants are not
met several times over a defined period, the acquisition-financing bank may termi-
nate the acquisition loan and order repayment. Financial ratios that are regularly used
in the monitoring of acquisition financing are:

• Dynamic net debt ratio ¼ net debt / EBITDA

• Interest coverage ratio on EBIT basis ¼ EBIT / interest expense

In general, however, the selection and definition of financial ratios and their
respective thresholds vary from corporate transaction to corporate transaction
(Rodde, 2012, p. 340) (Ernst & Häcker, 2011, p. 242).

Differences in Acquisition Financing for Medium-sized and Large Target

Companies in Corporate Buyouts
Large companies generally find it easier to approve and manage acquisition
financing than medium-sized companies. Issuing corporate bonds is a popular way
to finance acquisitions outside the banking sector. Large companies also have
advantages in on-balance sheet and off-balance sheet financing, as complex acquisi-
tion financing with subsequent syndication requires a certain minimum financing
volume to be attractive to companies from a cost perspective. On the other hand,
there is an increasing trend of financing instruments being offered to SMEs in
modified forms that have proved successful with large companies. Examples of
3.3 Phase III: Examination of Financial Aspects 107

this are SME bonds and the increased availability of cash flow-oriented acquisition
financing.
In principle, it can be said that the options for acquisition financing for SMEs are
limited to classic forms of financing. In the following, typical forms of acquisition
financing in SMEs will be discussed:

• Financing from the company’s own funds

• Financing through equity contribution by owners
• Financing through equity injection from investment companies
• Financing through equity injection through an IPO
• Financing through a classic bank loan

Financing from the company’s own funds:

The safest and probably the healthiest form of financing for corporate transactions
in the SME sector is financing through the company’s funds (internal financing),
which were created as part of the profit retention process. This ensures that the SME
buyer can actually afford the company acquisition. Failure to make the corporate
transaction a success would mean a loss of equity and thus significantly restrict
future investment opportunities. However, this worst-case scenario would not pose a
threat to the company’s existence.
Financing from the company’s own funds requires a successful business model
that allows high profits and pursues the strategy of not distributing the profits
generated to the owners but retaining them within the company.
Financing through equity injection by the owners:
If the equity available in the company is not sufficient to fully finance the
corporate transaction with equity, the owners of the company can inject equity
externally. Technically, this is done through an equity capital increase. Equity
injections by the owners could be observed during the financial crisis. Massive
business collapses lead to owners having to inject equity to ensure the survival of
the company in this critical phase. In practice, it is rare to see equity increases to
100 percent financing of company acquisitions with equity capital, as the owners of
medium-sized companies have often already invested a large part of their private
assets in the company. However, equity increases in mid-market corporate
transactions are more frequently observed when the equity base is to be increased
to be able to raise additional debt capital for acquisition financing.
Financing through equity injection by investment companies:
If the owners of the company are not available as equity providers for acquisition
financing, a capital increase by an equity investment company is an option. In
concrete terms, this means that for equity financing of a company acquisition, shares
in the acquiring SME are first sold to an equity investment company to be able to
finance the planned acquisition with the resulting capital increase in conjunction
with debt financing. For the SME, this means that it first sells a minority stake to a
financial investor (private equity company) before it can use this capital to finance
the acquisition. The inclusion of an equity investment company in the existing group
of shareholders is an option if the existing owners of the company are unable to
108 3 M&A Sales Process

finance the company’s growth through acquisition with equity capital, but the
acquisition is crucial for the further development and success of the company.
When involving an equity investment company, it is important to know that it is
only a temporary partner. The financing is earmarked for a specific purpose (in this
case, acquisition financing) and the financing horizon is correspondingly limited
(usually 5–7 years). After that, follow-up financing must be secured, which is often a
problem for medium-sized companies with limited financing options. Furthermore,
investment companies have high return requirements, approximately 15–25% IRR
(internal rate of return). This means that the company acquisition must be successful.
Otherwise, the ownership position of the existing shareholders is at risk, as equity
investment companies usually have put options granted in the investment agreement.
In simplified terms, put options mean that the equity investment company has the
right to tender its minority shares to the majority shareholders at a fixed IRR after
5–7 years. If the latter are unable to acquire these shares for financial reasons, the
equity investment company has the right to sell 100% of the shares in the company.
The parties involved then naturally receive shares in the proceeds of the sale in
proportion to their shareholding. However, this can also mean the loss of a family
business. In the worst case, the opportunity for growth through company acquisition
can result in the total loss of a stake in the company.
The management buy-out, which is so important for small and medium-sized in
which a manager or management team working in the company takes over the shares
in the company as part of a succession plan, is hardly feasible without financial
investors. However, there are only a small number of private equity companies that
focus on medium-sized companies. Most of the SME-oriented private equity
companies invest in companies whose sales are greater than 50 million euros.
Financing through equity injection by means of an IPO:
The item of financing a company acquisition through an IPO is only listed for the
sake of completeness. An IPO is a way of increasing the equity base of a company.
This is correct as far as it goes. However, the IPO represents a strategic development
in the corporate life cycle. This step from a medium-sized company to a listed
company represents an important milestone, the positive and negative consequences
of which must be carefully weighed. To put it briefly: No company will go public
because of the financing of an acquisition. Rather, corporate acquisitions following
an IPO are an opportunity to realize the company’s strategic goals (such as
expanding market share, entering new technologies, internationalization, etc.).
Financing through a classic bank loan:
The classic bank loan represents the central acquisition financing for medium-
sized companies. In principle, it corresponds to the senior term loan or a long-term
bank loan that is 100% secured. The collateral is the limiting factor for medium-sized
companies. If sufficient collateral is still available for acquisition financing in the
form of a traditional bank loan, this form of financing is generally readily available to
medium-sized companies. Since high-growth companies often finance their expan-
sion with borrowed capital, the collateral still available is often insufficient for larger
investments such as company acquisitions. A lack of collateral is a major obstacle to
3.3 Phase III: Examination of Financial Aspects 109

growth in SMEs. The only solution is to raise equity capital in the variants men-
tioned above.

Checklists: Overview of Acquisition Financing, General Conditions

of Acquisition Financing, Financing Instruments, and Process of Acquisition
Financing

Important
Checklist: Overview of acquisition financing
• The successful acquisition of a company or parts of a company always
depends on the availability of the financing funds intended for this purpose.
• The term acquisition financing stands for financing of the acquisition of a
company, part of a company, or a group of companies.
• Acquisition financing is a cash flow-oriented form of financing.
• Objectives of equity investors (financial investors):
(a) High profitability or high internal rate of return (IRR)
(b) Limitation of liability
(c) High contract flexibility
(d) Low costs
• Objectives of debt providers:
(a) Low debt financing ratio
(b) Loan collateral
(c) Syndication ability of the loan on the market
(d) High return on investment

Important
Checklist: General conditions of an acquisition financing

• In acquisition financing, the transaction volume is made up of the purchase

price and ancillary transaction costs (e.g., due diligence costs and
consulting fees).
• Two ways of structuring corporate buyouts:

1. Direct acquisition
In a direct acquisition, direct purchase of the shares in the target company
takes place by the strategic buyer itself.
2. Indirect acquisition

(continued)
110 3 M&A Sales Process

In an indirect acquisition, a single-purpose company is set up by the buyer to

act as the acquirer of the shares in the target company.
An indirect acquisition is usually carried out in five steps: 1) formation of a
single-purpose company, 2) provision of funds to the single-purpose com-
pany, 3) provision of funds to the target company, 4) acquisition of the
target company by the single-purpose company, 5) merger of the target
company with the single-purpose company.
In transaction practice, a combination of share deal and asset deal is often used.
The debt service capability, which is a decisive assessment basis for granting
the acquisition loans, is primarily determined through a cash flow analysis
(structured financing).
An optimal acquisition structure should meet the following requirements:
(a) The buyer often wants a limitation of liability on its equity investment.
(b) The transaction should be optimized for tax purposes.
(c) The financing structure must be acceptable to the buyer and the target
company.
(d) The financing must be secure. The required must be available on time and
in the required amount.
(e) The investors must be able to expect a return on investment commensurate
with the risk.
(f) The acquiring company or NewCo should be able to access the target’s
free be able to access free cash flows of the target company to service the
acquisition loans.
The following factors are regularly taken into account in selecting suitable
financing instruments:
(a) Transaction volume
(b) Legal form
(c) Company size
(d) Debt/equity ratio
(e) Collateral potential
(f) Liquidity situation and profitability of the target company
(g) Profitability
(h) Time availability of financing instruments
(i) Financing costs

Important
Checklist: Financing instruments

• In practice, the transaction volume for an acquisition is mainly provided by

liable equity and available debt capital.

(continued)
3.4 Phase IV: Closing Phase 111

• Any gaps in financing are closed, for example, by mezzanine capital.

• Accordingly, a financing mix is regularly selected to realize a planned
acquisition.
• Financing instruments for corporate buy-outs

(a) Internal financing instruments

(i) Open and silent self-financing
(ii) Asset restructuring
(b) External financing instruments
(i) Debt financing instruments: senior term loans and Working
capital loans
(ii) Hybrid financing instruments (mezzanine): Equity mezzanine and
debt mezzanine

Important
Checklist: Procedure of an acquisition financing

• The actual process of an acquisition financing depends on the complexity of

the planned M&A transaction, the quality of the transaction preparation,
and the experience of the parties involved.
• Analyses before the transaction closing: Management case ! due diligence
phase ! revised business plan and financing case ! final financing
structure ! signing and closing
• Analyses after transaction closing: Monitoring

3.4 Phase IV: Closing Phase

The concluding stage of a company sale is the closing phase. Up to this point in the
M&A process, extensive preparatory work has been done, both by the seller and the
buyer and their advisors. All parties involved have invested a lot of time and nerves
in the process and aim to get the corporate transaction wrapped up. However, this
does not mean that once the contract negotiations have been concluded, the transac-
tion is as good as certain. The final phase before the final contract is signed is
considered a critical stage in which many M&A transactions fail (Wirtz, 2012,
p. 291). Often, a lack of compromise, diverging price expectations, or suddenly
emerging information or risks of the target company can jeopardize the entire
transaction success.
112 3 M&A Sales Process

The closing phase of an M&A process is usually composed of the following

elements:

• Contract negotiations
• Binding offer
• Purchase contract (signing)
• Closing

3.4.1 Contract Negotiations

The duration and intensity of purchase agreement negotiations between the seller
and the buyer depend on the complexity of the corporate transaction and the existing
level of agreement, e.g., regarding the purchase price or guarantees, between buyer
and seller. In addition to the legal form of the contracts, with a strong focus on buyer-
side guarantees, the purchase price to be paid is negotiated (Mohr & Bärtl, 2012,
p. 247). During or before the contract negotiations, it is important to develop a
feeling for the goals and wishes of the other negotiating party. The contract
negotiations aim to reach agreements on both sides that meet the expectations of
both the buyer and the seller. Both parties should come out of these negotiations with
the feeling that they have gained more than they had to give up (win-win situation).
Negotiations aimed at reaching an agreement on a corporate merger or acquisition
have a significant impact on the transaction outcome. The success of a transaction is
not determined solely by excellent corporate and transactional analysis. Besides,
strong negotiating skills are of crucial importance. The investment bank or M&A
boutique therefore often prepares its client extensively for the negotiations.
Preparations for negotiations in an M&A transaction include the following main
activities (Ernst & Häcker, 2011, p. 57):

• Evaluation of the current strategic situation and alternative strategic measures for
the buyer and the target company
• Valuation of the target company using different valuation methods
• Determination of a price range (incl. the walk away price)
• Mastery of various techniques and tactics in making an offer
• Determining the best alternative if an agreement cannot be reached
(BATNA ¼ Best Alternative To a Negotiated Agreement)
• Weighing up possible compromises
• Identification of key players and their interests
• Possible negotiation scenarios in advance in the head playing through
• Checking the reputation of the other party
• Evaluate the impact of negotiation costs

Current negotiations can be conducted with a focus on the following (Ernst &
Häcker, 2011, p. 57):
3.4 Phase IV: Closing Phase 113

• Search for compromises

• Open and honest negotiation strategy
• Taking into account the importance of the time factor
• Maintaining respect for the corporate culture of the other party

Essential negotiation tactics include (Ernst & Häcker, 2011, p. 57):

• Separation of issues from people

• Focus on interests instead of positions
• There are no winners or losers
• Looking for a win-win solution for both parties
• Price and corporate governance must not be neglected
• Establish objective criteria

In addition to negotiation preparations, points and tactics, potentially occurring

risk factors must also be considered. If the chemistry between the two parties (e.g.,
between the CEOs of the buyer and seller) is not right, no price in the world will
bring about a transaction closing. Such a situation could be caused, for example, by
an unintentional insult or slight to one party, causing that party to take a defensive or
dismissive stance. Furthermore, adverse movements in the stock market or interest
rates may affect the negotiation phase. Such scenarios can suddenly make the
financing of a transaction considerably more expensive due to drastic price changes
in the capital market. A previously attractive corporate transaction can thus no longer
be carried out under target-oriented acquisition criteria, and negotiations are broken
off. Additionally, careful due diligence can reveal negative information about the
company for sale, which can create unexpected liabilities, tax and accounting
problems, and labor disputes. Such skeletons in the closet of the target company
may already prevent contract negotiations from materializing. The final risk factor
that can be identified is material adverse changes (MACs). In contrast to the case
with skeletons in the closet, in this situation, the buyer enters the final stage of the
transaction. If he then encounters a drastic change in the target company’s core
business that constitutes a material adverse change for the buyer, this gives him the
right to exit the transaction (Ernst & Häcker, 2011, p. 58).

3.4.2 Binding Offer

" Definition After a successful negotiation phase, the prospective buyer submits a
binding offer to the seller, which cannot be withdrawn without further ado.

A Binding Offer contains the following components:

• Final purchase price

• Required guarantees of the seller
• Competition clause of key personnel
114 3 M&A Sales Process

• Necessary approvals (e.g., from the antitrust authority, shareholders)

• Time frame for signing the purchase agreement

Together with the Binding Offer, the prospective purchaser submits the draft
purchase agreement amended according to its ideas. The original draft purchase
agreement was already sent to the potential purchaser during the due diligence phase
for review and revision. To evaluate the binding offer, not only should the stated
purchase price be used, but also attention should also be paid to the frequently used
contractual clauses in the draft purchase agreement that reduce the implicit value of
the offer. Some of these clauses are listed below (Rochat & Korp, 2010,
pp. 283–285):

• The buyer has the right to terminate the transaction if certain unforeseen events
occur (MAC clause ¼ material adverse change clause).
• The purchase price payment is to be spread over several years and linked to the
future profitability of the acquired company (earn-out clause).
• Excessive transfer of risks to the seller through extensive guarantees, which the
buyer demands from the seller.

3.4.3 Purchase Agreement

The purchase agreement contains all details necessary to complete the transaction. In
contrast to the Letter of Intent, it is a legally binding contract that is subject to certain
conditions (e.g., approval by the shareholders).

" Definition The signing of the purchase agreement by the purchaser and seller is
referred to as signing.

Certain transaction-relevant contents, such as possible synergy effects, financing

agreements, integration plans, etc., are not taken into account in the Purchase
Agreement. The reason for this limited focus is due to the function of the purchase
agreement. The purchase agreement is a risk management instrument that, in the
context of an M&A transaction, focuses mainly on the objective of closing the
transaction.
The essential items of a sales contract are (Ernst & Häcker, 2011, pp. 61–62):

1. Contracting parties
2. Preamble
3. Terms of the contract
4. Description of the transaction
5. Purchase price and payment
6. Warranties and guarantees
7. Legally binding promises
8. Closing conditions
3.4 Phase IV: Closing Phase 115

9. Termination conditions
10. Indemnification
11. Non-competition clause
12. Arbitration agreements

The type of business acquisition dictates the exact scope and structure of the
purchase agreement. In the case of an asset deal, the individual assets to be
transferred from the seller to the buyer as part of the M&A transaction must be
identified and listed in detail in the notes. This is not necessary in the case of a share
deal, as some or all of the shares in the target company are transferred. Thus, the set
of contracts for an asset deal is usually significantly more extensive (Behringer,
2013, p. 168).

3.4.4 Closing

" Definition The closing of the transaction represents the finish line of an M&A
transaction and is, therefore, the last step in the process from the seller’s point of
view or the point of view of its M&A advisor. To put it more precisely, the closing
falls on the closing date on which the actual authority to perform and entrepreneurial
responsibility are transferred from the seller to the buyer (Wirtz, 2012, p. 283).

Closing usually occurs only after several conditions have been met, such as the
approval from antitrust authorities and the approval of the shareholders. Although
major issues should have been resolved shortly before the transaction is closed, the
parties occasionally encounter stumbling blocks at this point that pose a threat to the
transaction. These usually arise because the parties suddenly place a higher value on
previously neglected negotiating points or one party behaves intransigently on a
matter. It is precisely this unwillingness to compromise that is intended to build up
pressure on the other party and still achieve a negotiating advantage toward the end
of the transaction. Such a strategy can jeopardize the entire transaction. The resulting
confrontation between the two parties and the loss of trust suffered can, even at such
a late stage in the M&A process, lead to the transaction being terminated. To avoid
such a danger, both parties should plan the closing thoroughly well in advance (Ernst
& Häcker, 2011, p. 62).
After the duty comes pleasure. As soon as the transaction is sealed, one of the
M&A advisors takes care of the closing dinner and the tombstone. At the closing
dinner, all parties involved in the process celebrate the successful end of the M&A
transaction in an appropriate location. In addition, all parties involved in the project
are each presented with a tombstone, an individual commemorative trophy often
made of acrylic glass (Trunk, 2010, p. 40).
116 3 M&A Sales Process

3.4.5 Differences in the Closing Phase of a Sales Transaction

for Medium-sized Companies and Large Companies

In the final stage of a company sale, both medium-sized companies and large
companies have to go through the steps just described. If we look at the details of
the individual sub-steps, some differences emerge.
When it comes to contract negotiations, the management level of a large target
company usually consists of managers who are well-trained in negotiation skills.
They often know important negotiation tactics and can adapt well to their
counterparts. The management level of a medium-sized company should in no
way be denied these attributes, but there is another important factor involved in
negotiation management. In medium-sized companies, the management level often
consists of managing partners or the company founders or their relatives. Unlike
managers, they have a close personal relationship with their company and see a
company sale as more than just a pure M&A project. Frequently, it is rather the life’s
work of an individual or a family of entrepreneurs that is being sold. This special
factor must of course always be kept in mind by the buyer and his advisors during the
contract negotiations. For example, a negative statement about the target company
on the part of a potential buyer can quickly be interpreted by the entrepreneur as a
personal insult and the mood of the negotiations can change in a flash. It is therefore
particularly important, if the seller has strong emotional ties, that the prospective
buyer has a certain degree of negotiating skill during the contract negotiations.
Furthermore, in addition to maximizing the sales price and minimizing guarantees
and warranties, job security and sustainable continuation of the company are impor-
tant negotiating points, especially in the case of medium-sized family businesses
(Wirtz, 2012, p. 285). Negotiations in the SME segment must therefore take into
account not only purely quantitative but also particular qualitative aspects.
A further difference, especially between small and medium-sized companies and
large companies, can be seen in the timing of signing and closing. In smaller
corporate transactions, signing and closing regularly coincide (Preisser & Cavaillès,
2011, p. 23). In contrast, as the size of the transaction increases, the time gap
between the signing of the purchase agreement and the successful closing of the
transaction often increases. The reason for this is, for example, the mandatory
involvement of antitrust authorities in the M&A process under certain conditions.
In course of an antitrust review, the antitrust authorities decide on the legal permis-
sibility of the planned acquisition of a company by a specific buyer. The subject of
this complex investigation is whether the corporate transaction will create or expand
a dominant market position and whether this will result in a restriction or distortion
of competition (Wirtz, 2012, pp. 26–27). It can therefore take some time before the
antitrust authority issues a notice of approval.
References 117

3.4.6 Checklists: Contract Negotiations, Signing, and Closing

Important
Checklist: Contract negotiations

• The duration of contract negotiations correlates strongly with the complex-

ity of a corporate transaction.
• Important points of negotiation are the purchase price to be paid and the
guarantees to be provided by the seller.
• It is important to have developed an understanding of the goals and wishes
of the negotiating partner in advance of the contract negotiations.
• Both the seller and the buyer should have gained more than they had to give
up (a win-win situation).
• Often, an open and honest negotiation strategy proves to be purposeful.

Important
Checklist: Signing and closing

• Signing is the signing of the purchase contract by the buyer and seller.
• Key elements of the purchase agreement are:
1. Contracting Parties
2. Preamble
3. Terms of the contract
4. Description of the transaction
5. Purchase price and payment
6. Warranties and guarantees
7. Legally binding promises
8. Closing conditions
9. Termination
10. Indemnities
11. Non-compete agreements
12. Arbitration agreements
• The closing is accompanied by the transfer of the actual authority to
perform and the entrepreneurial responsibility from the seller to the buyer.

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Appendix

Appendix 1: Calculation of Operating Free Cash Flow for Detailed

Planning Period (Ernst et al., 2010, p. 32)

Earnings Before Interest and Taxes

Adjusted taxes on EBIT
¼ Net Operating Profit and Losses after Taxes (NOPLAT)
+ Depreciation
+ Change in provisions
= Net Cash Flow

Capital expenditures

Change in net working capital
= Operating Free Cash Flow

Appendix 2: Calculation of Weighted Average Cost of Capital

(WACC) (Ernst et al., 2010, p. 45)

E D
WACC ¼ r e  þ r d  ð1
t Þ 
D TC

re ¼ expected return of equity investor

rd ¼ expected return of debt provider
t ¼ corporate tax rate
(1
t) ¼ tax shield
E ¼ market value of equity
D ¼ market value of debt
TC ¼ market value of total capital

# The Author(s), under exclusive license to Springer Nature Switzerland AG 2022 121
M. Dreher, D. Ernst, Mergers & Acquisitions, Management for Professionals,
https://doi.org/10.1007/978-3-030-99842-4
122 Appendix

Appendix 3: Calculation of Net Financial Liabilities (Net Debt)

(Ernst et al., 2010, p. 25)

Long-Term Bank Liabilities

+ Short-term bank liabilities
+ Liabilities to shareholders
+ Liabilities to affiliate companies
+ Other interest-bearing liabilities

Cash and cash equivalents
= Net debt

Appendix 4: Calculation of Cash Flow to Equity for Detailed

Planning Period (Ernst et al., 2010, p. 36)

Earnings Before Interest and Taxes (EBIT)

Interest on debt capital
= Earnings before Tax (EBT)

Income tax
= Earnings after Tax (EAT)
+ Depreciation
+ Change in provisions

Capital expenditures

Changes in net working capital

Repayment (+ borrowing) of debt capital
= Cash Flow to Equity (CFtE)

Reference

Ernst, D., Schneider, S., & Thielen, B. (2010). Unternehmensbewertungen erstellen und verstehen.
Ein Praxisleitfaden (4th ed.). Vahlen.
Glossary

Acquisition An acquisition represents the purchase of a previously independent

company or part(s) of a company and its subsequent integration into the
acquirer’s structures.
Acquirer In this context, an acquirer refers to a company buyer.
Acquisition financing The term acquisition financing stands for the financing for the
acquisition of a company, part of a company, or a group of companies. Acquisi-
tion financing is usually a cash flow-oriented form of financing.
Adjusted present value approach In the APV approach, as in the WACC approach,
the total value of the company is first determined. However, in contrast to the
WAAC approach, a notionally unleveraged company is assumed and the tax
shield is considered in isolation.
Anonymous short profile An anonymous short profile is a document, usually two
pages long, which contains essential information about the planned company sale
and the target company in anonymous form.
Antitrust review As part of an antitrust review, the relevant antitrust authorities
decide on the legal permissibility of the planned acquisition of a company by a
specific buyer. The subject of this complex investigation is whether the corporate
transaction will create or expand a dominant market position and whether this will
result in a restriction or distortion of competition.
Asset-backed securities Asset-backed securities (ABS) are securities or promissory
bills that guarantee payment claims against a single-purpose vehicle (SPV)
specially established for the ABS transaction.
Asset deal An asset deal is an M&A transaction in which the seller transfers
individual or all assets relevant to the business to the buyer.
Asset reallocation Asset reallocation involves the sale of fixed or current assets that
are no longer needed in the company. Thus, the company obtains liquid funds
quickly.
Asset restructuring The target company acquires assets which the hostile acquirer is
most unlikely to want or which may cause antitrust problems in the course of the
acquisition.
Asset stripping Asset stripping refers to the sale of non-operating assets, e.g.,
unused real estate or decommissioned machinery.

# The Author(s), under exclusive license to Springer Nature Switzerland AG 2022 123
M. Dreher, D. Ernst, Mergers & Acquisitions, Management for Professionals,
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124 Glossary

Auction An auction is a carefully supervised bidding process that gives the seller a
high degree of control over the modalities of the transaction.
Beauty contest Application competition by law firms, investment banks or transac-
tion houses for a major mandate.
Big four The four auditing firms with the highest turnover worldwide are Ernst &
Young, Deloitte Touche Tohmatsu, KPMG and PricewaterhouseCoopers. They
are referred to as the Big Four.
Binding offer After a successful negotiation phase, the prospective buyer submits a
binding offer to the seller, which cannot be withdrawn without further ado.
Borrowed capital Borrowed capital is the term used to describe the debts of the
company shown in the balance sheet (liabilities and accruals) that have been
legally incurred or economically caused. Borrowed capital is that part of the
capital which is not due to the owners but is attributable to other providers of
capital (creditors).
Business approach Under the business approach, an M&A process is described
from the perspective of the acting companies. This view is mainly represented in
the Anglo-American area.
Business plan The business plan provides a roadmap for the startup and future
operations.
Business cooperation In the context of a business cooperation (e.g., joint venture or
strategic alliance), the participating companies cooperate voluntarily and remain
legally and economically independent in the areas not affected by the
cooperation.
Buy-and-build strategy A buy-and-build strategy pursues the goal of acquiring
companies to build a larger or more diversified group of companies.
Buy-out A buy-out refers to the purchase or buy-out of a company.
Capital expenditure Capital expenditure (Capex) is capital expenditure on longer-
term fixed assets, such as machinery, buildings, but also original equipment, spare
parts, computer systems, etc.
Cash flow Cash flow describes the amount of liquid funds that a company receives
on balance within an accounting period.
Cash flow to equity Cash flow to equity is the portion of a company’s cash flow that
goes to the company’s equity investors.
Clean down To ensure that the working capital loan is actually used to finance
current assets and not, for example, for long-term investments in fixed assets, a
full repayment of the working capital loan (clean down) is generally contractually
agreed once a year.
Closing The closing of a corporate transaction occurs on the date on which the
actual authority to perform and entrepreneurial responsibility are transferred from
the seller to the buyer.
Closing dinner At the closing dinner, all parties involved in the process celebrate
the successful end of the M&A transaction in an appropriate location.
Comparable companies analysis See also trading multiples method
Comparable transactions analysis See also transaction multiples procedure
Glossary 125

Company valuation A company valuation serves to determine the market value of

the equity of a specific target company. The result of a valuation is always a range
of enterprise values, which serves as a basis for decision-making.
Company acquisition A company purchase is either the acquisition of certain or all
company shares or the acquisition of certain or all assets of another company.
Confidential business report See also information memorandum
Confidentiality agreement Under a non-disclosure agreement (NDA), both the
seller and the potential buyer agree to maintain absolute confidentiality about
the transaction and any confidential information exchanged.
Company sale A company sale is either the sale of certain or all company shares or
the sale of certain or all assets to a third party.
Corporate buy-out A corporate buy-out—an acquisition of a company by another
company—is understood to mean the takeover of a target company by a strategic
investor rather than a financial investor.
Corporate transaction See also mergers and acquisitions
Corporate mergers and acquisitions See also mergers and acquisitions
Covenants Covenants are clauses in loan agreements that give the lender the right to
perform certain actions if certain defined events occur.
Credit risk Credit risk refers to the specific risk incurred by commercial banks when
granting loans that, for example, contractually agreed interest and principal
payments will be partially or fully defaulted on (credit default risk).
Credit agreement A loan agreement is a contract by which a credit institution
(lender) undertakes to grant a loan to another person or company (borrower) on
the terms agreed between the two parties.
Crown jewels The target company sells particularly attractive and lucrative busi-
ness units (jewels) to a friendly company or carries out a spin-off. This can
eliminate synergy potential from the perspective of the hostile acquirer and
make the hostile takeover unattractive.
Data room A data room is a physical or electronic data pool containing a variety of
essential information about the target company that the seller provides to potential
buyers for analysis.
DCF method In practice, discounted cash flow methods are considered the most
relevant valuation methods. The DCF method interprets the enterprise value as
the sum of the expected future cash flows of the company discounted to the
present.
Deal See also mergers and acquisitions
Deal breaker Deal breakers are factors that, if known, would cause a potential buyer
to abandon the transaction.
Deal maker Deal makers are factors that, if known, would lead a potential buyer to
proceed with the transaction.
Debt mezzanine If a mezzanine capital instrument is structured close to debt capital,
it is referred to as debt mezzanine (or senior mezzanine).
Debt service The debt service is the interest and repayment service for loans taken
out.
126 Glossary

Debt service capability Debt service capability expresses whether a borrower is able
to repay the loan taken out within the agreed term or to service the principal on the
respective payment dates.
Dilution Dilution of equity, e.g., through the exercise of an option or conversion
right.
Direct acquisition In a direct acquisition, the shares in the target company are
acquired directly by the acquiring company itself.
Discounted cash flow method See also DCF method
Due diligence The systematic analysis of the target company by a potential buyer
prior to signing a purchase agreement is referred to as due diligence.
Earn-out financing In case of earn-out financing, the purchase price to be paid by
the buyer to the seller comprises a fixed purchase price component and a
performance-related (variable) purchase price component (earn-out).
Economies of scale Economies of scale are defined as a reduction in fixed costs due
to an increase in output volume.
Economies of scope Economies of scope are understood to mean, for example, the
exploitation of cost advantages in heterogeneous product programs.
Electronic data room Electronic data rooms accessible via the Internet have now
become established as a market standard in the context of an M&A due diligence.
Enterprise value The enterprise value (EV) corresponds to the sum of the expected
future cash flows of the company discounted to the valuation date.
Enterprise value multiple The enterprise value multiples are used to calculate the
total value (EV) of the target company, i.e., the market value of the equity and
debt capital.
Equity In contrast to debt capital, equity capital includes those funds that have been
raised by the owners of a company for its financing or have been left in the
company as generated profit.
Equity kicker If an equity kicker is agreed, the mezzanine capital provider simulta-
neously receives the right to become a shareholder in the company to be financed
when the mezzanine capital is provided. This entitlement takes the form of an
option or a conversion right.
Equity mezzanine If a mezzanine capital instrument is structured close to equity, it
is referred to as equity mezzanine capital (or junior mezzanine).
Equity value Equity value (EqV) is the market value of a company’s equity.
Equity value multiple Equity value multiples are used to determine the market value
of the equity (EqV) of the target company.
Equity approach Future cash surpluses are determined and discounted with the cost
of equity, to which only the equity investors are entitled. The result is the direct
market value of the company’s equity.
Excess cash flow The cash flow remaining after repayment of the senior loan
tranches (excess cash flow) flows into the cash fund and can be used, for example,
to finance current assets or for investments in fixed assets.
Executive summary The purpose of an executive summary is to summarize the key
points of a document for the relevant decision-makers.
Glossary 127

Exclusivity agreement Exclusivity agreements grant a party a certain degree of

exclusivity under various conditions.
Exclusive procedure The exclusive process is a one-on-one sales process in which
the seller could identify the optimal acquirer in advance of the transaction.
External financing In the case of external financing, the required financial resources
are provided either from capital sources outside the company, e.g., in the form of
equity contributions or investments, or from loans and credits.
Factoring Factoring is the sale of the company’s own trade receivables from third-
party debtors to a so-called factoring company.
Financial covenants Certain financial covenants are used as a control instrument for
the development of credit risk during the term of the loan. They are recorded and
defined in the loan agreement.
Financial due diligence Determining an accurate and objective picture of the target
company’s current and future assets, financial position and earnings. Deal
breakers are sought.
Financing case To determine debt service capacity, acquisition-financing banks
establish financial models (bank case or financing case), which are used to
determine the available cumulative free cash flows of the target and the acquirer
(or only the target) to repay debt in a direct (or indirect) acquisition.
Financing gap A financing gap occurs when equity contributed and the available
debt are not sufficient to finance the transaction volume. In this case, mezzanine
capital, for example, can be used to close the financing gap.
Financial investor Financial investors are, for example, private equity houses (e.g.,
Advent International or EQT Partners) or hedge funds (e.g., J.P. Morgan Asset
Management or Bridgewater Associates).
Free cash flow Free cash flow is the portion of cash flow available to the company
after deducting necessary capital expenditures (capital expenditures) and changes
in working capital (working capital). This part is decisive for the calculation of
enterprise value using the discounted cash flow method.
Free float The free float is the proportion of shares in a stock corporation that is
accessible for trading on the stock exchange because it is not in the hands of the
firm as a larger block.
Friendly takeover A friendly takeover is when the management of the target
company approves the change of ownership.
Full financing As part of acquisition financing, all existing bank liabilities of the
target company are usually paid off and replaced by bank loans from the
acquisition-financing bank(s). This is to ensure that the target company is fully
integrated into acquisition financing through loan agreements that regulate the
target company’s obligations is made.
Fungibility Fungibility refers to the exchangeability or substitutability of goods,
foreign currencies, securities and standardized futures contracts. In general, the
exchangeability of a right or a thing.
Fusion See also merger
128 Glossary

Gap analysis A gap analysis is used to identify operational and strategic gaps in a
particular business.
Globalization Globalization is a political-economic term for the progressive process
of worldwide division of labor.
Golden parachutes In an event of a hostile takeover, oversized special payments to
the management of the target company may be agreed. As a result, it may become
too costly for the potential acquirer to gain control by replacing the existing
management.
Goodwill Goodwill is that part of the purchase price for a company which exceeds
the value of the tangible and intangible assets of that company after deducting
debts.
Hedge funds Investment funds with a certain variety of investment assets and
strategies. Hedge funds aim for absolute positive return, i.e., they do not follow
a benchmark. They are considered a type of fund that uses highly speculative
investment techniques.
Hidden reserves Hidden reserves are parts of a company’s equity that cannot be
seen on the balance sheet. They arise as a result of the undervaluation of assets
and/or the non-capitalization of assets eligible for capitalization and/or the waiver
of possible write-ups and/or overvaluation of liabilities.
High yield bonds As soon as corporate bonds are subordinated (in terms of liability
and yield) and thus carry a higher interest rate commensurate with the risk, they
are referred to as high-yield bonds.
Horizontal integration A business combination of two companies at the same stage
of the value chain is referred to as horizontal integration.
Hostile takeover Hostile takeovers are takeover attempts that are made against the
will of the target company’s management.
Hybrid financing instruments Mezzanine capital is a hybrid financing instrument
and can be classified between equity and debt.
Incidental transaction costs Incidental transaction costs include due diligence costs
and consulting costs. They often range from 3.5% to 5.0% of the purchase price.
Indicative valuation An indicative business valuation is an initial valuation of the
target company that does not yet provide the accuracy of a full business valuation
due to incomplete information.
Indicative offer See also letter of intent
Indirect acquisition In an indirect acquisition, a single-purpose company is
established by the buyer to act as the acquirer of shares in or assets of the target
company.
Information asymmetries Information asymmetries result from difference in the
level of knowledge of the seller and prospective buyers about the target company.
Information memorandum The information memorandum represents the central
sales document in an M&A process. The memorandum is a comprehensive report
containing essential information about the target company. Based on this infor-
mation, a potential buyer can form a realistic opinion about the current situation
and future development of the company.
Glossary 129

Internal financing In internal financing, the required financial resources are

generated in the operating performance and sales process.
Internal rate of return The internal rate of return is the rate of return earned on the
capital tied up in an investment project. The internal rate of return provides
information about the return-on-investment projects or the effective interest rate
on financing measures.
Interest coverage ratio The interest coverage ratio provides information on how
well the company is able to service its interest. The higher the interest coverage
ratio, the more easily the interest can be financed from the earnings generated by
the operating business. (Interest coverage ratio ¼ EBIT / interest expense)
Investment grade A company (or its bonds) that has a good to very good credit
rating (rating: e.g., at least BBB- from Standard & Poors, or at least Baa3 from
Moodys) receives an investment grade rating from a rating agency. This attests to
the company’s ability to make timely interest payments and repay the borrowed
capital.
Investment bank The business activities of an investment bank consist of asset
management for its customers, trading in securities and advising customers on
corporate acquisitions and takeovers, IPOs and other capital market transactions.
Joint venture A joint venture is a subsidiary that is established and managed by two
independent companies.
Junior Mezzanine See also equity mezzanine
Large-cap See also large company
Large company The adjusted segment of large companies includes all companies
with more than 2000 employees and annual sales of more than EUR 500 million.
Legal due diligence Identification of all legal risks. Serves to hedge against poten-
tial legal obligations resulting from the acquisition. Deal breakers are sought.
Letter of intent The letter of intent is a declaration of intent with the character of a
preliminary contract. The letter of intent does not result in any legal commitment
on part of the potential buyer or seller. The LOI underpins the seriousness of the
purchase interest and creates a mutual basis of trust.
Leveraged buy-out A leveraged buy-out (LBO) is the acquisition of a company
with partial financing of the purchase price by debt capital.
Listed company A listed company is a company whose shares are listed and traded
on a stock exchange.
Loan collateral Loan collateral is assets (property and rights) that are intended to
protect the creditor against the risk of default (credit risk) arising from a loan.
Loan tranches The debt capital raised for acquisition financing is mainly composed
of senior term loans of different tranches (A, B, C, D, etc. tranches).
Long List A long list contains a rough selection of as many suitable buyers as
possible.
M&A player This refers to both the seller of the company and prospective buyers
who are involved in the M&A process.
M&A boutique M&A boutiques are independent specialized consulting firms
focused on M&A advisory services.
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M&A project See also sale of a company and acquisition of a company

M&A process From a seller’s perspective, an M&A process is generally divided
into four phases: Preparation phase, market approach, illumination of financial
aspects and closing phase. From the buyer’s perspective, the post-merger inte-
gration phase is added at the end as the fifth phase.
M&A waves See also merger waves
Management buy-in A management buy-in (MBI) is the acquisition of a company
by an external management team to take over its management together with
(or instead of) the existing management.
Management buy-out A Management Buy-Out (MBO) is the purchase of a com-
pany by its own management.
Management case The business plan of the target company provided by the seller is
called the management case.
Management presentation Management presentations are often held shortly before
the opening of the data room. In terms of content, a management presentation
deals with investors’ unanswered questions and other details about the company
and corporate strategy that are not clear from the information memorandum or
other sources.
Management Summary See also executive summary
Mandate agreement As part of an M&A transaction, a mandate agreement is
concluded between the target company and an M&A advisor. The mandate
agreement mentions in detail the seller’s transaction objectives and its
expectations toward the advisor.
Marketing book See also information memorandum
Market approach Market approach in an M&A process is contacting of potential
buyers by the investment bank or M&A boutique.
Material adverse changes Material Adverse Changes (MAC) refer to significant
adverse changes that give a particular party the right to withdraw from the M&A
transaction.
Majority interest A majority interest is a term used when the majority of the shares
of a legally independent company are owned by another company or person, or
when another company or person holds the majority of the voting rights.
Medium-sized enterprise This adjusted definition of a medium-sized enterprise
includes all companies that have between 50 and 2000 employees and annual
sales of between 10 and 500 million euros.
Memorandum See also information memorandum
Merger The term merger describes the amalgamation of two independent
companies to form a legal and economic unit.
Merger multiples See also transaction multiples method
Merger waves The market for M&A is characterized by periodic appearance of
upswings and downswings. While the individual merger waves have different
drivers, historically external shocks can always be identified as triggers that create
adjustment pressure in the affected industries and markets.
Glossary 131

Mergers and Acquisitions Mergers and Acquisitions (M&A) are mergers and
acquisitions of companies or their subdivisions or subsidiaries.
Mezzanine capital Mezzanine capital refers to a hybrid financing instrument that
combines the characteristics of equity and debt.
Mid-Cap See also medium-sized company
Minority interest A minority shareholding is when a company or a person holds a
minority of the shares and/or voting rights of another company. of another
company.
Monitoring Monitoring is the ongoing analysis of credit risk after the conclusion of
an acquisition-financing transaction.
Multiples method In the multiples methods, the sought-after value of a company to
be valued is determined using multiples derived from the known market values of
other listed comparable companies or past M&A transactions.
Net approach See also equity approach
Net financial debt Net debt is the sum of all financial liabilities minus cash.
NewCo See also single purpose company
Non-equity kicker The exercise of an option or conversion right leads to a dilution
of the previous shareholder rights. This dilution can be counteracted by agreeing
on a non-equity kicker, in which the mezzanine capital provider participates in the
increase in value of the company to be financed without becoming a shareholder
himself.
Non-recourse financing In case of indirect acquisition, a single-purpose company in
the legal form of a limited liability company & limited partnership is interposed
between the buyer company and the creditor. This limits the personal liability of
the buyer to the equity contribution to the single-purpose company. This form of
financing, which excludes any recourse to liability on the part of the purchasing
company, is known in specialist circles as non-recourse financing.
Non-solicitation clause The interested buyer must refrain from hiring employees of
the target company, usually for a period of 1–2 years, following termination of the
confidentiality agreement and the associated transaction termination.
Open-ended investment In an open-end investment, the investor acquires shares in
the target company.
Offering memorandum See also information memorandum
Operating free cash flow The cash surpluses available to satisfy the claims of all
providers of capital—both equity and debt—are referred to as operating free cash
flows.
Parallel procedure In parallel procedure, an M&A advisor is engaged to identify a
selected number of suitable potential buyers and, after consultation with the
seller, to contact them separately.
Physical data room A physical data room is the collection of relevant company
documents in a designated location or room (often at the seller’s lawyer’s office).
Pitch book The pitch book is prepared by an investment bank or M&A boutique in
advance of a beauty contest. The pitch book is the business card of an investment
132 Glossary

bank and usually comprises 60–80 pages, depending on the expected transaction
volume.
Pitch presentation A pitch presentation or pitch is the application of a law firm,
investment bank or transaction house for a consulting mandate, e.g., in the
context of a beauty contest.
Poison pills Existing shareholders of the target company have the right to purchase
a certain number of shares in the target company at a discounted price in the event
of a takeover attempt.
Poison put Contracts are in place with the target company’s lenders that stipulate
immediate repayment of the loans as soon as control of the target company
changes.
Post-merger integration After the M&A transaction is completed, the buyer has to
merge or integrate the target company into its own group of companies. This
integration phase is referred to as the post-merger integration (PMI) phase.
Principal–agent conflict Principal refers to owners of the company, who are partners
or shareholders, depending on the type of company. Agents are classically
managers who are supposed to protect the interests of the owners and manage
the company in a sustainable and value-creating way. If the managers make
decisions not based on the owners’ long-term corporate goals but, for example,
on their own sales-related bonus payments, this is referred to as principal–agent
conflict.
Private auction A selected group of potential buyers is invited to a private auction.
An investment bank is usually entrusted with preparing and conducting the
auction.
Private equity Private equity is equity provided by private or institutional investors.
It is used by investment companies (private equity houses) to acquire company
shares for a limited period of time.
Prospectus See also information memorandum
Public auction A public auction takes place in a highly competitive environment
among a large number of bidders and thus usually enables a high selling price.
Purchase price The purchase price is the agreed consideration that a buyer must pay
to the seller after signing the purchase agreement.
Purchase contract The purchase agreement contains all the details necessary to
complete the transaction.
Retainer A retainer is a non-performance-related compensation component that the
M&A advisor receives monthly, for project-related costs, from the target
company.
Revolving Credit Facility See also working capital loan
Retention of earnings Retention of earnings means the retention of profits generated
by a company within a certain period and not distributed to the shareholders.
These retained profits can, for example, be used later for the acquisition of a target
company.
Ring-fencing In finance, ring fencing is the isolation of a specific project or assets to
protect them from external risk factors.
Glossary 133

Sale-and-lease-back In sale-and-lease-back, certain parts of the operating (fixed)

assets are sold to a third company (often a special leasing company) in order to
subsequently lease them back to the company itself.
Selling price See also purchase price
Screening In the context of M&A transactions, screening is the systematic search
for and selection of suitable buyers depending on specific requirements.
Self-financing Self-financing is understood to mean internal self-financing through
the retention of profits (open self-financing) or the release of retained earnings
and hidden reserves (dormant self-financing).
Senior mezzanine See also debt mezzanine
Senior A tranche Compared to other senior tranches, the senior A tranche usually
has the shortest loan term of usually not more than 7 years.
Senior B tranche In this tranche, the loan amount is often repaid in a single payment
at the end of the term (bullet repayment). The term of a senior B tranche is usually
1 year longer than that of a senior A tranche. Due to the longer term and bullet
repayment, the borrowing costs of a senior B tranche are higher than those of an A
tranche.
Senior C tranche Similar to B tranches, senior C tranches are bullet loans with a
loan term 1 year longer than B tranches. As a result, they are repaid after the B
tranches and therefore carry a higher interest rate.
Senior term loan Senior term loans are long-term financing instruments with typical
terms of between 5 and 9 years, which are repaid according to a precisely defined
repayment schedule defined in advance. Senior term loans are considered to be
financing instruments with the lowest risk of default in acquisition financing
because they are generally well collateralized and, in the event of insolvency,
are repaid in priority to all other financing instruments.
Service approach The service approach describes an M&A process from the per-
spective of the M&A advisor involved.
Share deal If the buyer acquires shares in the target company as part of an M&A
transaction, this is referred to as a share deal.
Share price The share price is the price at which a share is traded on the stock
exchange.
Shareholder loan In contrast to a regular bank loan, the capital in a shareholder loan
is not provided by new capital providers from outside but from within the
shareholder group.
Short list The short list contains a selected number of the most suitable who will be
approached in the next M&A phase.
Short profile See also anonymous short profile
Signing The signing of the purchase agreement by the buyer and the seller is
referred to as signing.
Single-purpose company In the context of M&A, the sole purpose of a single-
purpose entity is to acquire the assets or shares of the target company. Thus, the
single-purpose vehicle itself does not conduct any operational business. The legal
form of the SPV is often a Ltd. in order to limit the personal liability of the buyer
134 Glossary

to the equity contribution to the SPV. Other names for a single-purpose company
are NewCo (New Company), SPV (Special Purpose Vehicle) or SPC (Special
Purpose Company).
Silent partnership Under silent partnership, the investor becomes a silent partner in
the target company and receives a regular dividend corresponding to the
contribution made.
Special purpose vehicle See also single-purpose company
Spin-off A spin-off is the separation of an organizational unit from existing corpo-
rate structures through the establishment of an independent company.
Squeeze-out A squeeze-out is a squeeze-out procedure for the transfer of shares
held by minority shareholders to the majority shareholder in return for appropriate
cash compensation.
Staggered board There is a staggering of contracts of the Supervisory Board and
Executive Board members. This makes it more difficult for a hostile acquirer to
replace the existing management and control body.
Stock price See also share price
Stock exchange The term stock exchange is used to refer to both the stock exchange
building and the stock exchange as an organized market for trading in fungible
assets that are commonly determined by number, measure, or weight in traffic.
Strategic due diligence Thorough examination of whether the prospective buyer can
achieve its strategic goals on the basis of the acquisition (strategic fit). The most
important subject of examination is the business plan of the target company. Deal
makers are sought.
Strategic fit This term describes the harmony or fit between the buying and selling
companies. The more different two companies are, the more difficult a business
combination will be and thus the more complex an M&A project will be.
Strategic alliance A strategic alliance is an agreement between two or more
companies to cooperate on certain business activities so that each benefits from
the strengths of the other and gains competitive advantages.
Strategic investor Strategic investors are interested in expanding and meaningfully
diversifying their business. Their focus is not on achieving purely short-term
financial gains, but on realizing potential synergies and a long-term investment
horizon.
Structured financing Debt service capacity, which represents a key measurement
basis for acquisition lending, is determined primarily through a cash flow analy-
sis. In contrast to the granting of a typical bank loan, assets play less of a decisive
role in structured financing for the collateralization of the loans than the cash
flows for debt repayment.
Success fee The success fee is a performance-related compensation component that
an M&A advisor receives from the seller after the successful closing of a
transaction. The success fee corresponds to a percentage share of the subse-
quently achieved transaction value.
Glossary 135

Succession planning Succession planning is often an issue for family businesses as

soon as the previous managing partner wishes to step down from the management
of the company for age reasons and a successor is sought.
SWOT analysis A SWOT analysis (Strengths, Weaknesses, Opportunities, and
Threats analysis) is a positioning analysis of the target company in relation to
its competition.
Syndicated loan A syndicated loan is provided by more than one financial institu-
tion (syndicate) to a borrower. Particularly because of its size or the special risk
involved, the loan is not granted by a single bank but by several for reasons of risk
diversification.
Synergy effect A synergy effect is the positive effect resulting from the merger or
cooperation of two companies or the like.
Target company In the context of a company sale, the target company is understood
to be the company for sale.
Tax due diligence Examination of the tax situation of the target company and
identification of tax risks. Deal breakers are sought.
Tax shield Tax shield refers to the tax savings from the use of borrowed capital,
interest and other financing costs.
Teaser See also anonymous short profile
Tombstone An M&A tombstone contains high-level information about the transac-
tion in question. The name of the seller, buyer, and M&A advisor are mentioned,
as well as the nature of the transaction. An online tombstone serves as a reference
for an M&A advisor on its website, whereas a Plexiglas tombstone acts as a
personal memento.
Track record A track record is an individual reference list about successes of
investments, consulting services, etc.
Trading multiples How much would the company being valued be worth on the
stock market today if compared to similar listed companies?
Transaction multiples Based on comparable transactions completed in the past, how
much would the company being valued approximately pay today?
Transaction volume The transaction volume mainly comprises of the purchase
price, the funds required to repay existing liabilities to previous banks and former
owners of the target company, and incidental transaction costs (e.g., due diligence
costs or consulting fees).
USPs USP is the abbreviation for unique selling proposition. USPs are intended to
set one’s own product apart from competing products by highlighting its unique
benefits and to encourage consumers to buy it.
Valuation package In practice, several valuation procedures are always used and the
respective results are then compared and interpreted.
Vendor due diligence In the preparatory phase of a sales process, the seller some-
times commissions a so-called vendor due diligence (VDD), which is intended to
provide an independent assessment of the target company. It examines the legal
and tax basis as well as the financial, asset, and earnings situation of the company.
136 Glossary

Vendor loan The vendor loan or seller note is a way of bridging diverging purchase
price expectations between the buyer and seller. In this case, part of the purchase
price is converted into a loan. The seller becomes from a shareholder to a lender
and grants the buyer of the target company a (usually subordinated) loan.
Vertical integration Vertical integration is a business combination of two
companies that are at an upstream/downstream stage of production or value
creation.
WACC approach The WACC approach is one of the discounted cash flow methods.
According to this approach, the enterprise value is first determined on the basis of
total free cash flows. This is done by discounting the future cash flows with the
weighted average cost of capital of the company to be valued. The net financial
liabilities are then deducted from the calculated enterprise value to obtain the
equity value.
Walk away price The walk away price is the price at which the prospective buyer
withdraws from the sale because it becomes too costly for him.
Weighted average cost of capital (WACC) WACC is the abbreviation for Weighted
Average Cost of Capital. This is a mixed interest rate comprising the cost of
equity and the cost of debt.
White knight A friendly company makes a higher takeover bid and thus drives up
the purchase price. In addition to a majority stake, this white knight can also
provide the target company with sufficient funds as a substitute to prevent the
hostile takeover.
Working capital loan The working capital loan is designed to ensure that the target
company has sufficient liquidity to finance working capital. It is a revolving credit
facility.