Thought Leadership | Bob Malhotra

Strategic areas to focus on during M& A Transactions

We will be pleased to share our experience and provide answers and solutions to some of these questions:

Why business owners and investors want to sell businesses?
What is investors motivation to buy the business?
What will the investors be looking at in a business?
Is your business ready “to be sold” and fit for purpose?
What Valuation methodology to use and why?
What would be required for investor due diligence?
How to create meaningful information memorandums?
How well polished is the founder’s story?
How to maximize EBIDTA?
How to present shareholder value and synergies to the businesses?

Stages of Funding:

Being an entrepreneur or a startup founder isn’t an easy task, especially when it comes to the matter of fundraising from investors and going through the funding stages. The below table shows a clear picture of the funding stages and what exactly the startup should possess in order to find investors and convince them to invest.

Investment Size with Company Stage:

Different companies at different stages of their lifecycle have differing investment requirements.

Each requirement of fund raising needs to be fulfilled with different types of investors. Angel investors are required in the early stage of the company development whilst Corporate Venture Capitalists are required on mature stage for company growth. Enclosed is a matrix to outline this:

What is Mezzanine Financing and when can this be used?

Mezzanine financing is yet another type of financing used by the early stage businesses startups which are similar to raising funds in between equity and traditional bank loans.

These are also known as Bridge Loans.

The Mezzanine Investors do not ask for collateral unlike banks, but charge higher interest rates which range between 12% to 20%. This makes the mezzanine financing very perilous.

The investors also require the right to convert their equity, if the company defaults on the loan.

However companies opt for Mezzanine Financing, because it gives them the final push to exit quickly and go for the IPO or any business acquisitions

What is Bridge Round Funding?

When the startup companies are short on funds, this situation is also called ‘running out of runway, they resort to what is called Bridge Round funding.

Companies come to the conclusion of raising bridge rounds, only when their alternate your option is to shut the business.

Bridge round funds help the companies to meet their working capital needs and also to ‘bridge’ the funding gap between the startup’s current funding round and the next funding round.

Bridge funds are raised from venture capital debts and equity.

What is Series Funding?

As the name suggests, Series funding is a continuous series of funding stages for a startup that comprises Series A, B, C, D, E and at times beyond to even Series F, G, H and so on.

In each of these series, the startup raises more funds and thus increases their value.

Series A Funding:

Series A funding usually surfaces majorly from Venture Capital firms and the angel investors and seed investors from the previous stages slowly commence their exit.
Crowdfunding is also a way through which many companies raise Series A funding.
This round is usually led by a single investor who takes control of the round.
For the startups, getting this first investor is very crucial as it is often seen that once an investor invests in a startup, finding and convincing other investors to invest becomes easier.
Nevertheless, losing the first investor can prove to be detrimental as the other investors will also back out.
At this stage, the investors are no longer interested in the extraordinary idea.They are more inclined towards the future prospects of the company such as its projected growth, cash flows generation and how successful the company will be.
Usually the startups raise around $2 million to $15 million in the Series A funding.
The approximate valuation of a company raising Series A funding is between $10 million and $15 million.
This stage is yet another testing period as many startups fail in this round. This situation is called ‘Series A Crunch’ and it happens majorly to the early stage startups.

Series B Funding:

If a startup reaches this stage of Series B funding, it means that the startup has proved to the investors that they are an upcoming successful venture.
At this stage, the startups have already developed customer bases, have found their product or market fit and are ready to move to the next level.
Funding in this stage is raised from the same investors from Series A funding.
An additional stream of funds will be received from venture capitalists who specialize in later-stage investing.
These funds are used for expansion and for meeting the increasing customer base.
Expansion would require a growing quality team, sales, marketing and advertising, technological support and human capital, since the founder cannot do all the roles now and to make sure that the startup succeeds.
Around $7 million to $10 million is raised from Series B funding and the company is valued approximately between $30 million and $60 million.

Series C Funding:

Once the company reaches Series C funding, it means that the company is doing a great job.
At this round, the companies aim to expand to new markets, take their products to international markets, acquire other businesses and even diversify their product line.
The planning for going public (IPO) is also at this stage.
The company is very successful and has found its own position in the market. The operations of the company becomes less risky, because of which at this round, one can see the entry of private equity firms, hedge funds, investment banks and similar investors injecting their capital into companies expecting to receive returns twice as much as invested.
In the Series C funding round, startups raise around $26 million and the valuation of the company is approximately between $100 million and $120 million.
The valuation is based on actual data such as the customer base, revenue, expected growth etc and not expectations.
This might be the last stage of funding before the company goes public, even though some companies go for Series D and E funding
For most of the companies, Series C funding is the last round to raise funds. However, certain companies goes further for the next round of funding and sometimes beyond to raise funds due to growth requirement reasons

Why do investors like annuity (annual) revenues?

Annual revenues provide a clear and predictable measure of a company's performance over a fiscal year. Consistent annual revenues indicate stability and reliability, making the business more attractive for investment. They also allow for better financial planning and forecasting, helping investors assess growth potential and return on investment. Predictable annual revenues reduce risk, as they show a steady demand for the company's products or services, which can lead to higher valuation and investment appeal.

Why is the right structure important before selling?

Structuring your business correctly before selling is crucial for several reasons:

Tax Efficiency: An optimized structure can minimize tax liabilities for both the seller and the buyer.
Maximizing Value: A well-organized business with clear financials, efficient operations, and legal compliance can command a higher sale price.
Attractiveness to Buyers: Buyers look for businesses that are easy to integrate, have minimal risks, and are straightforward to understand.
Legal and Regulatory Compliance: Ensuring all legal and regulatory requirements are met reduces the risk of future liabilities

Have you built the fit-for-purpose target operating model?

A fit-for-purpose target operating model ensures that your business operations are aligned with strategic goals and market demands. This involves:

Efficiency: Streamlining processes to reduce costs and increase productivity.
Scalability: Designing operations that can grow with the business without significant restructuring.
Flexibility: Ensuring the model can adapt to changing market conditions and business needs.
Alignment: Making sure all parts of the business work together towards common objectives, enhancing overall performance.

Importance of a realistic future business plan?

A realistic future business plan is essential for guiding the growth and development of the business. It:

Sets Clear Goals: Provides a roadmap with achievable milestones and targets.
Secures Investor Confidence: Demonstrates to investors that the business has a viable path to growth and profitability.
Mitigates Risks: Identifies potential challenges and outlines strategies to overcome them.
Resource Allocation: Helps in allocating resources efficiently to areas that will drive growth and profitability.

Is the business a strategic fit for the investor?

Ensuring the business is a strategic fit for the investor involves:

Alignment with Goals: Matching the investor’s strategic objectives and investment criteria.
Complementary Strengths: Leveraging the investor’s resources and expertise to enhance business performance.
Synergy Potential: Identifying areas where the business and investor can create value together, such as cost savings or revenue growth.

What are synergies and how to evaluate them?

Synergies refer to the benefits that arise when combining two businesses. Evaluating synergies involves:

Cost Savings:Analyzing potential reductions in operating costs through economies of scale or eliminating redundancies
Revenue Enhancement:Identifying opportunities to increase sales by leveraging combined customer bases, cross-selling, or expanding market reach.
Strategic Alignment:Ensuring the businesses complement each other’s strengths and fill gaps in capabilities.
Integration Feasibility:Assessing how easily the businesses can be integrated to realize these synergies.

Maximizing return on equity?

To maximize return on equity (ROE), focus on:

Profitability:Increasing net income through revenue growth and cost management.
Asset Management:Efficiently using assets to generate higher sales and profits.
Debt Management:Using leverage prudently to enhance returns without taking on excessive risk.
Capital Allocation:Investing in high-return projects and avoiding unprofitable ventures.

Importance of reviewing and managing liabilities?

Reviewing and managing liabilities is essential for:

Financial Health:Ensuring the business can meet its obligations and maintain solvency.
Creditworthiness:Maintaining a good credit rating to secure favorable financing terms.
Risk Management:Identifying and addressing potential financial risks that could impact the business.
Long-term Sustainability:Ensuring the business is not overburdened with debt, which can hinder growth and operational flexibility.