Thread by @GlogauGordon

Rumblings on "Private-to-Private" M&A deals

From an M&A practitioner perspective, I can't help but to think there will be a newfound appreciation for the level of complexity involved in consummating these specific types of transactions in today's environment

Let me explain...🧵

Talks of a wave of "VC-backed consolidation" over the next 12-18 months have been pervasive in various Valley circles recently, and manifesting in the form of:

🤝 Buyers using '21 valuations opportunistically as "M&A currency"

🤝 "Roll-ups of last resort" for subscale players

There have been a number of "private-to-private" all-stock (or majority stock) combinations that have been consummated before

Two "success stories" that come to mind are 1) Seamless + Grubhub and 2) Elance + oDesk (now $UPWK)

But these deals have enormous underlying complexity

After the Seamless Grubhub tie up in '13 @bgurley wrote a nice piece about 3 sets of challenges that permeate "private-private" M&A deals:

1⃣ Structural
2⃣ People
3⃣ Investor / founder mindset

All non mutually exclusive issues exacerbated by idiosyncratic "valuation conundrum"

To state the obvious: you get a daily "report card" in the public markets with a definitive view on "absolute value"

Absent a construct to facilitate discovery of "absolute value", it's VERY hard to determine "relative value" in the private markets (see Grubhub-Seamless case)

"Relative value" is the framework for determining how the "absolute value of one company compares to another

In a stock-for-stock deal, this underpins the deal's "exchange ratio" (i.e. the # of shares a buyer issues to the seller for each share they own) and ownership split

Public-to-public "all stock" mergers (like $CLDR + $HDP) marketing points denote the core elements:

"Deal Terms: Each [Target] share will be exchanges for [X] [Buyer] shares"

"PF Ownership: [XX]% [Buyer] shareholders / [1-X]% [Seller] Shareholders

So advisors will underscore parties should alter their thinking in negotiations to "not get hung up on valuation but focus on ownership"

That's mostly correct assuming what you "get" is worth more than what you "give"

That said, "cap table drama" can further complicate this

Private cap tables underscore per @matt_levine that "mergers aren't always fair"

Buyers & sellers have different share classes with different value

Seniority, dividends, participation, antidilution provisions & liquidation preferences impact the economics & swap mechanics

"Esotericism" in "public-to-public" "all-stock" mergers is *typically* ill-received but private markets are unbridled with respect to "form of consideration"

Buyers can get creative here in issuing common or preferred (existing or new w/ rights, ratchets, warrants etc) or both

From a seller's perspective...

The "relative value" calculus & exchange ratio should account for the potential inequity or "cramming" by the preferred stack (i.e. investors) onto common holders (i.e. management) driven by the triggering of "goodies" like liquidation preferences

From a buyer's perspective...

The "relative value" calculus & exchange ratio should account for existence of any antidilution provisions in their own capital structure that could be triggered as a result of issuing "cheaper" capital to a seller by virtue of "self-devaluing"

Ultimately, the components of relative value underpinning the exchange ratio can obfuscate the incentive alignment and "upside participation" that is shared between the various classes of investors (i.e. management & investors) between and within buyers and sellers respectively

Furthermore, it's worth reiterating a key existential & fundamental point

Given lack of "value discovery", private stock is effectively an option predicated on a "strike" of a qualifying exit

As a seller, by swapping stock you are effectively relinquishing control of your exit

As such, there is a strong perception that only sellers without any options (absent a strong incentive or participation) would participate in a private-to-private company stock swap merger (as is seen in opportunistic acquires made by larger buyers)

But it's not always the case

In a true merger, the people and governance structure should more or less be commensurate with the pro forma ownership underpinned by the discussion around "relative value" &contribution to ensure that the right balance of incentive alignment, control & motivations are guarded

These go right when:

1⃣ "Us vs them" thinking swapped for "partnership mentality"

2⃣ Realities of structural complexity are embraced, not dismissed

3⃣ Combined model & synergies trump individual contribution

4⃣ Relative value perceived to be more critical than absolute value

Thanks to @bgurley, @arampell, @jrichlive, @Matt_Levine_1, @gokulr, @peteflint for inspiring my thoughts (from a dealmaker perspective)

Follow me at @GlogauGordon for dives on #mergersandacquisitions, #SaaS and other topics

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