Middle Market Deals and how to buy, sell and raise capital from $5 to $500 million

Colgate-Palmolive Company (NYSE:CL) announced last week that Tom's of Maine, a manufacturer of fluoride-free natural toothpaste-(click here for a post about why that might be good), had agreed to a deal.

Colgate will pay $100 million for the acquisition of 84% of the outstanding shares; the founders will retain 16%, allowing Colgate the option to acquire additional shares in the future.

Tom's of Maine co-founders Tom and Kate Chappell said (apparently in chorus):

We chose Colgate as our partner because they have the global expertise to help take Tom's of Maine to the next level. Just as importantly, we see Colgate as an excellent fit with our own cultural values. Colgate has a commitment to product excellence, to global efforts to promote oral health and has a 200-year history of caring for consumers and for giving back to the community. We are excited by Colgate's desire to continue Tom's of Maine leadership and heritage in natural care.

One of the most frequently unasked questions, but one that everyone wants to understand, is what is a fair M&A advisory fee?

To be clear, for a firm that genuinely plays the role of a broker-dealer or investment bank, operating under the requisite legal framework, the answer falls into a fairly narrow band. 

Ignoring the costs of any required fund raising (see my post on fees for raising capital) the fees for advising the buyer or seller in the middle market arena, tend to follow the 5-4-3-2-1 "Lehman Formula."

The Lehman Formula provides that the advisors get 5% of the first million, 4% of the second, 3% of the third, 2% of the fourth and 1% of all the consideration above four million. 

How an entrepreneur chooses an intermediary to help with a transaction depends on a variety of factors.

There is not a bright line between what makes a middle market financial adviser a business broker or an investment bank.  Those monikers are typically self-selected.

Here are some considerations.

*The lower the transaction value, the more likely that a self-described business broker rather than a self-described investment bank is to tackle your deal.  To be clear, however, there is no line of demarcation and some self-described business brokers effect larger middle market transactions, while some self-described investment banks execute smaller middle market transactions, but this information is a fair guide as a rule of thumb.

Investment Bank:  As an investment banker, I've learned that most people in the middle market world don't have a clear understanding about what an investment bank does.

Most people do understand that large investment banks help take companies public, but may not appreciate what else they do or how they might help a company that is not seeking to go public.

Ultimately, a public offering (IPO) is means of accomplishing two objectives: 1)  create liquidity for owners and investors, and 2) raise capital to facilitate growth or reduce debt.

Middle market companies often seek to accomplish these objectives without an IPO.  Middle market investment banks can help to accomplish both by using private offerings to raise capital or mergers and acquisitions to help create liquidity.

Today, many private equity firms--who generally rely on intermediaries, including investment banks for deal flow--are willing to allow entrepreneurs to take money off the table at the time of an investment, accomplishing both of the objectives of the IPO without a public offering.

Investment banking firms are typically registered with the NASD.

Business Broker:  A business broker is a business intermediary who facilitates transactions between buyers and sellers of small and middle-market businesses.  Most frequently, business brokers are retained by the sellers.

The traditional model operates much like a real estate brokerage, with a focus on creating a portfolio of listings, if you will, of businesses for sale.   Depending on the firm, these listings range from small mom and pop businesses up to businesses with millions in revenue.  Such listings are typically provided in proprietary or in shared databases.

The model works well for entrepreneurs who are sellers of small businesses and for sellers who are interested in exposing their properties to the market to see what the traffic will bear. 

Generally, business brokers are not registered with the NASD.

There are two groups of people reading this post; I apologize to both of you because I'll try to take the time to write this post so as to be relevant to both groups.  One group knows what a reverse merger is and wonders why I suggest that you run away from it.  The other group wants to know what a reverse merger is and why I suggest that you run away from it.

For group two, a reverse merger is a merger between a private company, typically with a small but promising business, and a public company that has discontinued its operations, leaving only a "shell" with publicly traded shares.  The transaction is usually structured with the public company acquiring the private one and subsequently changing the name of the public company to the name of the private company.  Because the public company had no operations, it likely had no officers.  The private company officers become the officers and directors of the public company.  Voila, the private company is public without a public offering.  Oftentimes, a third party or parties, will contribute equity capital to the newly combined company to provide needed capital.

It sounds easy enough, so you ask, what's wrong with that?

Entrepreneurs and executives, often ask when, or in the alternative, why they might need a fairness opinion on a purchase or sale transaction.

The primary reason for the Board of Directors of a selling company to seek a fairness opinion is to establish, primarily for the benefit of minority shareholders who lack board representation or whose votes won't count (because of their relatively low shareholdings), that the transaction as contemplated is fair to all shareholders.

The Board is, as you might imagine, seeking to insulate itself from claims of those who may disagree with the decision.  There are a variety of legal maneuvers employed to manage this risk, including the use of an auction procedure to demonstrate that the highest or at least best bid has been received, reviewed, negotiated and ultimately accepted.  Good counsel will usually recommend a "belt and suspenders" approach, utilizing multiple means of protecting the board from rancorous shareholders.