“[Mechanics] can make up anything; nobody knows! Why, well you need a new Johnson rod in
here. Oh, a Johnson rod. Yeah, well better put one of those on!”
“The PSA is preceded by a Q of E as part of the DD, which is preceded by a LOI, which is preceded by an IOI, access to the VDR which follows the MNDA and of course the CIM”. Am I the only one who thinks that people who talk this way sound like teenagers in heat? LOLRather than speak plainly, Investment Bankers often communicate in a very confusing manner.They do that to intimidate their clients and make themselves appear smarter than they really are. It’s a subtle power play. Listeners rarely admit that they don’t know what the Investment Banker is talking about. The ‘expert’ can say almost anything.
M&A transactions are complex in the best of circumstances. There are many moving parts. We at Turk & Co believe that everyone involved in our processes (buyers and sellers) should fully understand what’s going on. After all the client is the one who pays for the party!
I want to demystify the world of Mergers and Acquisitions in the title industry. This blog explains the basics of the process from the perspective of the Seller (a future blog will explain how we handle things when we represent the Buyer) and offers a glossary of the most commonly used technical phrases and acronyms sprinkled with a few helpful hints.
Understanding the industry jargon will empower clients.
Let’s start by putting all this in a proper context. “Mergers And Acquisitions’ (M&A) sounds lofty and fancy. All that really happens though is that someone with a business wants to sell and someone with money wants to buy. We put the deal together and help satisfy the buyer that what the seller says about the business is true. It’s kind of like a dating service combined with robust veracity verification (so lying won’t work), except instead of people we match companies.
A proper and compliant M&A process is conducted by a licensed Investment Banker (like us) who is heavily regulated and registered with the Financial Industry Regulatory Authority(FINRA) and the U.S. Securities and Exchange Commission (SEC). Some Sellers try to sell their business themselves and some use business brokers. An Investment Banker is more proactive and will have access to a broader range of potential buyers (including national and global buyers) than a broker or someone flying solo and will stay actively involved in the closing process. Having a motivated professional involved in the due diligence process improves the odds of the deal closing. Business brokers mostly work with local and regional buyers and will typically operate in a more passive manner and merely post a potential transaction on the Internet (sort of like throwing spaghetti on the wall to see what sticks) and then wait to see who might be interested. Selling solo limits the buyer options only to those the seller knows.
Our focused and deliberate strategy is always better.
The process starts with an ‘Engagement Letter’. This sets out the terms of your relationship with the Investment Banker. The economics should be explicit. What the banker will do and the process they will use should be clear and unambiguous. Typically, the Banker will charge a monthly retainer as well as a success fee based on the ‘Enterprise Value’ of the transaction. There are many definitions of ‘Enterprise Value’. Prudent sellers pay attention to whether it includes earn outs. It is important for the seller to understand that ordinarily they are obligated to pay success fees on the portion of the deal which is an earn out. No banker gets rich on the monthly retainers; rather the retainer is designed to ensure unanimity of interest and that the seller is serious about selling. The Engagement Letter typically contains tail language, so that some of the obligations the Seller is agreeing to will continue subsequent to the termination or expiry of the agreement.
Before going to market, the Investment Banker should be comfortable with the seller’s financials and build a Financial Model. The model may involve adjustments to the EBITDA (Earnings Before Interest, Depreciation and Amortization). EBITDA is commonly used as a barometer of financial health because it is basic and overcomes different accounting methodologies. It better allows for comparison between timelines and companies. An adjustment is a modification to the financials to better depict what those financials might look like post acquisition. Typical ‘adjustments’ reflect non-recurring or personal expenses. As a seller, you want to find legitimate and defensible adjustments because a multiple of any increase in EBITDA improves the business’ Enterprise Value.
As part of the process of preparing a Financial Model, we conduct a review of the business. Selling and closing the deal are two very different things. Sometimes, a business looks good, but it does not survive the due diligence process. A properly run due diligence process reveals everything. If time allows, we like to run our prospective clients through a similar review before taking them to market so that we identify and remedy any problems which might inhibit the prospects of a deal closing. Because we wear two hats (title experts and Investment Bankers), we know exactly what to look for. For example, we look at the ratio of escrow losses to top line revenue. If that is higher than our standard, we’re going to look for examples of the loss. If we see the same type of problem recurring, we’re going to ask for the firm’s training log (since escrow losses are ideal training items). If there is no training log, we’ll ask for the firm’s Best Practices policies and procedures. If they don’t have that, well, then we’re going to have a different discussion.
Classically, the Investment Banker should then develop a list of potential buyers. We don’t do this because we already have our list (we’re not new and our list is ever changing as fresh investors become interested in title and come to us). The list should contain ‘Strategic’ and ‘Financial’ buyers. ‘Strategic’ buyers are those already in the title industry (i.e. other title agencies, title underwriters, or those involved in ancillary businesses). ‘Financial’ buyers are typically Investors. Each have different goals and different valuation metrics. Conventional M&A wisdom is that ‘Strategics’ pay more, but we’ve seen the opposite in the title industry. There are also hybrids, namely title agencies (Strategics) who are institutionally owned or backed by private equity (Financial). Those often are the best buyers because they understand the industry, have access to capital and can augment that with an accretive synergy strategy(think: 1 + 1 =3).
Once the list and model are ready, the banker should prepare a Teaser, a marketing piece intended to generate interest in the transaction. Done properly it portrays the profile of the selling firm in a way that prevents anyone from guessing who the seller is. A teaser should never contain confidential information. Typically, the teaser profile will include items such as the nature of the business of the agency (split between residential and commercial for example, rough idea of footprint, retail versus institutional originations etc.), size of the business, some indication of profitability reasons why the business is attractive (i.e. good management, high margins, good technology, unique product mix etc.).
Let’s pause for a moment and allow for a short rant. I’m known to give these from time to time. The Teaser stage is the beginning part of the process where things can go sideways.
While I feel blessed to be able to work with so many wonderful people at the different title agencies, underwriters and financial institutions we cross paths with, I am also endlessly astonished at the lengths some firms (yes -underwriters too) will go to in order to outdo one another in behaving unethically. For some in the title industry, avarice is primary and behaving with integrity is clearly nothing more than optional. I don’t know why this is so. It’s certainly not necessary since the title industry is large enough to support everyone. There is enough to go around.
Harm can come in the form of a raid on a client’s staff by prospective buyers or the spreading of rumors that a company is for sale to their customers as part of an attempt to steal business.
Regardless of my personal disdain for how some in the industry conduct themselves, prudence dictates that we design every step of our process around suspicion and mistrust. We’re paternalistic when it comes to our clients and work hard to protect them from potential harm. Each and every step of all we do is structured with that in mind. It’s not foolproof (nothing really is) but we go to extremes to mitigate this very unfortunate but real risk.
Here’s an example of how we look out for our clients: our Teasers are always accompanied by a blank Non-Disclosure Agreement (NDA). The reason the NDA is blank is to allow the seller an opportunity to stop the process if they do not trust the buyer. Beyond that we only feed information to prospective buyers as is necessary at each step of the process. No one gets customer lists or employee names until well into confirmatory due diligence (after the winning suitor has been chosen).
“Mistrust is a theme in our M&A process’.
After NDAs have been exchanged the banker typically will distribute a document known as a CIM (Confidential Information Memorandum). This document (which can be lengthy and have lots of pretty colors) outlines the story of the seller and portrays the results of the Financial Model.
We only use CIMs infrequently. They are excellent tools and common practice by Investment Bankers when marketing to prospective buyers who do not know the title industry. We have learned over the years that CIMs are not that important IF we are marketing a title agency to buyers already familiar with the title industry (i.e. others already in the business or investors who have taken the time to become familiar with how title works).
Instead of a CIM, we go straight to a Virtual Data Room (VDR) whichcontains detailed disclosures of information prospective buyers need to see. We build two VDRs, namely one which contains sufficient detail buyers like to see so that they can form a decision as to whether to proceed to a proposal and a second which is far more robust and facilitates confirmatory due diligence. Sometimes, we modify or enhance the VDR to suit the needs of specific buyers. For instance, a marketing initiative to an Underwriter will delineate CPL fees from overall remittance in the VDR. The present value of future premium remittance is important to an Underwriter, but because CPL fees carry different profit margins than premium, we like to be clear as to how much of the remittance is attributable to CPL fees. That helps our client maximize the opportunity with an Underwriter. This level of detail would not be important to a Financial buyer.
Using our VDR1/VDR2 approach instead of a CIM saves a lot of time and allows us to get to closing much quicker. Buyers often tell us how much they appreciate the time saved by us just telling them what they really need to know (we know what they need to know because we represent buyers all the time too). Time is not the friend of many deals.
We offer a free training on the title industry to Private Equity. By combining those who have done the training with firms we know are already invested in the title business we have a proprietary list of about 700 Financial buyers which augment our list of about 650 Strategics. Typically, we will refine our marketing efforts so that overtures are sent only to firms who would be appropriate buyers.
A Bid Process Letter is then sent out to all who have signed NDAs. This letter outlines the timelines and specifications for Indications of Interest. The letter should ask the prospective buyer to specify a range of value and outline their methodology approach to valuation. The methodology is important because it helps the seller make an informed decision as to who the winning suitor will be.
An Indication of Interest (IOI) is a non-binding letter outlining at a high level the interest a prospective buyer has in the target seller. It should specify a range of value, outline the rationale or methodology behind the range, indicate where the money to pay for the transaction will come from, outline basic terms such as all cash or an earnout portion, and describe the buyer and their plan for the business. Sufficient detail should be provided to enable the seller to make an informed decision as to next steps. Sometimes, prospective buyers indicate nothing more than that they are ‘interested’. We encourage them to provide as much detail as they can to help the Seller evaluate the various overtures it receives.
Management Meetings are usually held after the IOI winners have been selected, but sometimes they occur before if we know the buyer and they are qualified. Ostensibly the Management Meetings are designed to provide swift answers to additional questions the Buyer may have. We find that they also enable the Seller to interview the Buyer and form an opinion as to how they might work together. Cultural alignment can be just as important as financial considerations and the Management Meetings are excellent opportunities for the Seller to get to know prospective Buyers.
The Seller will then select one (or more) to proceed to a LOI (Letter of Intent). Like the IOI, this letter is not binding. The difference between the LOI and the IOI is that the LOI follows a process the seller engages in to select a winning suitor and can reflect an agreement relation to price, terms, reasons for any price adjustments, the deal structure, defined time frame for due diligence, exclusivity, earn out provisions, employment contract details and more.Confirmatory due diligence will follow the LOI.
Confirmatory due diligence is basically predicated on mistrust. The buyer verifies everything the seller has represented. This can range from reasonable to ridiculous. The timeline for this stage can vary, depending on the process of the Buyer. Some Buyers will want to conduct a Quality of Earnings (Q of E) report, which is somewhat analogous to an audit and usually conducted by an outside accounting firm.
Once Confirmatory Due Diligence is concluded a Definitive Agreement is signed. Sometimes, drafts of this are circulated and negotiated during confirmatory due diligence. It typically is signed just prior to or at closing. The Definitive Agreement documents the transaction and includes the final price, clarity as to where the financing (if any) is coming from, conditions for the escrow, representations and warranties and more.
I’m hoping that this blog will prove helpful to anyone interested in buying or selling a business in the title industry. Selling or buying a business is a big deal, and the best decisions are always ones which are fully informed. Investment Bankers should want their clients to know what they are talking about! Remember, whether it is a buy side or sell side engagement, the Investment Bank exists to serve the client, not the other way around.
A word from our sponsor (us): Our firm is fully licensed with the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) as an Investment Bank for Mergers and Acquisitions. We are not ‘business brokers’. We’ve closed more title industry deals for both buyers and sellers than any other Investment Bank in the US.
We’re fluent in acronym.