First Contact - Rules of Engagement in M&A

Some three and a half years after the debt markets got paralysed - that's 15 quarters now - there is a realistic chance now that the raft of VCs running around - especially in UK legal services markets - can finally stop "fishing without hooks". Trade buyers have been trundling along at a tick over level, but largely unchallenged, until now. So if a deal flow is to re-emerge, a reminder of the rules of first contact would be timely:

The problem with "first contact" is that it is usually botched, so here are some lessons from an old soak who's seen most of them (and been guilty of quite a few).

1. Do the homework first. Deals do come out of the blue, unsolicited, or from a chance meeting, but they usually only show that you don't know as much as you need to. These are the deals which typically result in "impairment reviews" a year or two post completion. If you don't know the firms you would like to acquire or be acquired by, you are effectively abdicating your strategy and enterprise valuation to strangers (to you and the market). Know what is known as your "addressable market", your role in it, and why you are better/different - and have the numbers to prove it.

2. Advisers advise, principals decide. The corporate finance world is full of experienced deal makers, rain makers, thought leaders and assorted other grand terms for commission junkies. Unless you are in the business of making dozens of deals a year, however, you are simply the next burger to them, so be realistic. These "escorts" through the maze can be charming and cost effective, but they probably won't even recognise you, let alone respect you in the morning. Its your baby, its your cash, it's your call.

3. "Who" makes the first approach is important. Everyone likes to keep their big guns until the last stages, so the initial contacts from trade players will often be from other directors. The best (and the worst) of these are line directors with a "real" job, not group special projects or business development roles. They're best when they have some humility and know what they don't know. They're worst when they are simply too rough and think running a big established business model is the same thing as entrepreneurial ability. Precisely what makes them a great executive director can make them a very poor M&A leader, especially when looking at competitor deals. Group directors and VC introducers can be good, but there is still a stage to be gone through after this where you get to know the real culture of the contacts.

4. Talking at all shouts loudest. Letting the VC telemarketer in or agreeing to a first meeting offsite, is not non-committal; it says your hat is in the ring. If you are not for sale, don't take the first step. If you are - do your homework on who buys what, how often and why. (Some smaller firms use this process as a cheap valuation exercise. It has repercussions though, as you will be seen as damaged goods or unreliable thereafter. Dabble if you must, but crying wolf cuts your multiples and/or serious bidder list when you do get serious.)

5. Mind the gap. Owner managers are usually living in the numbers for the 12 months ahead - the last set of published accounts are ancient history. For buyers the last 2 or 3 years of numbers gives a hunch of what's where, but if these are abbreviated balance sheet reports, they really are guessing. The difference can be significant, especially in growing companies in growing markets - usually the ones you try to buy into. Be patient with what is effectively a 3 year data gap. What looks like a £1m business to the researching buyer, can turn out to be a £3-4m one by the time you get there (and vice versa). It matters. Disappointment is as easy to display as excitement.

6. Forget the fag packets. The headline deal numbers of the latest super deal are almost always an irrelevance. VCs tend to forget that even if they don't use DCF valuation approaches, vendors certainly do when calculating the cash impact on their lifestyle post deal. The multiples issues is not that secret (See RBP's Briefing Note: VCs - What Are They Good For (and how much)?). So stick to realistic numbers and aim for a win/win deal. Simple really.

To see exactly the sort of information VCs and trade buyers use in assessing the M&A landscape of the Legal IT market, see RBP's "Legal IT: M&A Perspectives 2011 Q1 report

http://www.rbponline.co.uk/rbpsectors.asp?sector=LTS