Mergers & Acquisitions done on a “Cash & Debt Free” basis !
Author: J.J.P. (Joris) Kersten, MSc RAB
Kersten Corporate Finance @ Uden/ The Netherlands
February 13th 2021
Source used - book: Crushing it as a corporate buyer in the middle market (2020). Kevin Tomossonie. Rock Center Financial Partners, New York.
Introduction Kersten CF
Kersten Corporate Finance is an independent M&A consulting firm in The Netherlands.
Deal segment: Middle sized and SME companies. So companies with an Enterprise Value (EV) of in between 2 million euro and 50 million euro @ The Netherlands and Benelux.
Activities:
1.Selling companies;
2.Buying companies;
3.Business Valuation & Financial Modelling;
4.Financing of acquisitions with bank loans and/ or private equity firms;
5.Buy & Build strategies for strategic buyers;
6.Searching & selecting acquisition targets;
7.Finding multiples for precedent M&A transactions in a certain field.
Website M&A consulting: www.kerstencf.nl
Website M&A training: www.joriskersten.nl
M&A training:
·Business Valuation & Deal Structuring – 6 day training – 7 until 13 April 2021 – Location: Hotel van der Valk Uden/ The Netherlands – Also online available on live stream. 29 PE points for Registered Valuators (RV) from NIRV;
·Business Valuation & Deal Structuring – 6 day training – 29 September until 5 October 2021 – Location: Crown Plaza Hotel Amsterdam South – Also online available on live stream. 29 PE points for Registered Valuators (RV) from NIRV.
In addition, Joris provides valuation training all over the globe on (bulge bracket) investment banks and universities in: New York, London, Hong Kong, Singapore, Dubai, Saudi Arabia, Kuwait, Mongolia, Surinam and Peru.
130 references on M&A training: https://www.joriskersten.nl/nl/reviews
Intro to cash & debt free
Companies are generally valued at some measure of earnings or some expectation about future earnings.
And this represents the earnings of the underlying business you are buying.
So earnings from the actual operations of that business.
And not the earnings of things that do not necessarily belong to, or represent, those operations, like its capital structure !
(Kevin Tomossonie, 2020)
Capital structure
The capital structure of a company is the amount of cash, short term investments, debt and equity, a company has on its balance sheet.
But this basically represents the result of all the past financial decisions that were made in that business.
So when there are things like gains or losses from short term investments, or interest expenses related to debt, this has nothing to do with the operations of that business.
This is why we separate the business’ operations from the capital structure in business valuation.
So we value businesses based on its operations, and this separated from whatever funding and financing decisions were made in the past.
And this is what is meant with valuation “cash & debt free”, so free from capital structure from the past owners.
(Kevin Tomossonie, 2020)
Deal cash & debt free
Valuation cash & debt free means valuating a company like is has no cash or debt in it.
Here fore we start valuating the business purely on its operations.
And generally this is called the “headline price” of a M&A deal.
Also quite often this is called the “enterprise value” (EV).
So in general a buyer wants to pay a certain headline price (enterprise value) for a company, based on the value of its operations.
And then the seller will be responsible for paying off any debt that the business has.
When there is any cash left after paying back the debt, the seller will then get paid for that on a "euro for a euro basis".
But if there is not enough cash in the company to pay back the debt, then it will need to come out of the seller’s earnings from the deal.
So in that case, paying back the debt is deducted from the headline price (enterprise value).
(Kevin Tomossonie, 2020)
The benefits of deals cash & debt free
These type of deals are very practical from a seller’s perspective.
This because when there are many bidders on one deal, it is easy to compare the bids, since you can judge/ compare the “headline price” (enterprise value) they offer.
But it also benefits the buyer !
This since it will take a lot of time to:
·Agree on a price for a M&A deal;
·Negotiate a letter of intent (LOI);
·Perform the due diligence (DD);
·Negotiate final terms in a SPA or APA.
And in the mean time, the amount of cash and debt is most likely going to change.
Potentially it could change a lot, but this does not matter with a “cash & debt free” deal.
This because the headline price (enterprise value) stays the same.
And the “net debt adjustment” provides us with a mechanism that settles the level of cash & debt in the business at the time of closing the deal.
(Kevin Tomossonie, 2020)
Source used - book: Crushing it as a corporate buyer in the middle market (2020). Kevin Tomossonie. Rock Center Financial Partners, New York.
In the following blogs on this topic I will talk about:
·The net debt adjustment;
·Working capital adjustment;
·Working capital targets;
·Locked box mechanism.
