At the Austin Dale Group, we work with entrepreneurs and owners to grow and realize optimal value for their businesses. Healthcare and healthcare technology M&A is a key part of our practice, both on the buy-side and the sell-side, as are recurring revenue and software-as-a-service (SaaS) businesses.
Business changes are often the result of market forces that are outside of the control of entrepreneurs. Timing in an M&A process is critical. If important market changes happen during an M&A process, they can have a material impact on the timing and/or outcome of a transaction.
We documented this recent example of a company sale, which illustrates how adverse market changes can be handled. Good management, open communications, and patience can overcome even the most difficult situations.
Sleep Systems and Solutions (S3) grew out of a need to improve patient resupply services for a durable Medical Equipment (DME) company. David Baxter owned Medical Necessities, a company that provided sleep therapy equipment and other durable medical equipment to patients.
Sleep therapy equipment supports patients suffering from sleep apnea and other medical conditions. The equipment can markedly improve the quality of life of patients, but it includes a variety of consumable components, such as masks, tubes, and filters, which need to be replaced on a regular basis. Replacement requirements vary by equipment type and patient usage, and it can be difficult for patients and suppliers to keep track of resupply needs.
Initially, David’s focus was to solve the resupply problem for Medical Necessities. He created a call center with specially trained “sleep coaches” and equipped them with computer systems and databases containing information about patient resupply needs. The sleep coaches contacted patients and helped them stay current with their equipment resupply needs. Patients were happy because they got the equipment that they needed, and their medical equipment continued to operate effectively. Doctors were happy because patients got optimal therapy for their conditions. DME manufacturers were happy because they got consistent revenue from the resupply of DME equipment.
Industry stakeholders noticed the success that Medical Necessities was having and encouraged David to offer his resupply support services to other DME retailers. In 2015, Sleep Systems and Solutions (S3) was born. S3 worked side by side with Medical Necessities for several years and then was spun out into a standalone company after a large industry player acquired Medical Necessities from David in 2018. By 2020, S3 had grown substantially, and David contacted the Austin Dale Group for advice and support on strategic options for S3.
David Baxter runs multiple businesses simultaneously. As is often the case with successful entrepreneurs, he also had ideas and opportunities for new ventures that would require a personal time commitment and seed capital.
David also felt that S3 had grown to a size where it would benefit from a full-time dedicated CEO, a commitment that David could not make. After assessing the marketability and potential valuation of S3 with the Austin Dale Group, David elected to sell majority ownership of S3.
With a prospective sale, David wanted to:
When a company prepares for sale, it needs to understand the market, what buyers want and what commands the highest valuations. To the extent possible, it should tell its story by addressing what the market wants. These are key elements which the M&A Advisor provides.
Developing this story is a key collaborative activity that the Austin Dale Group facilitates as we prepare to go to market. It consists of a high-level Teaser document and an in-depth Confidential Information Memorandum (CIM).
The Teaser is used to build interest but does not include the name of the company that is to be sold. Once we develop enough interest from a prospect, we sign confidentiality agreements and share the CIM, which reveals the company name and detailed information.
S3 is a healthcare services company, a call center business, offers software-as-a-service (SaaS), and also provides business process outsourcing (BPO). Some of these services are more in demand by the market than others, and they command different valuation multiples. Our task was to distill this into a clear picture of the business, told in language that prospective buyers understand, which can often be quite different than the language that a company uses to sell its products to customers.
From our extensive experience in the healthcare and technology industries, the Austin Dale Group compiled a list of dozens of potential acquirers. We also elected to post listings on specialty websites which highlight companies for sale.
Interest from prospective acquirers was very high. Over 70 entities expressed an interest, signed confidentiality agreements, and reviewed the CIM. The team at the Austin Dale Group were busy for months handling buyer inquiries and meetings with interested parties.
Our job is to answer the repetitive questions and qualify the prospects to a core group. We reduce the disruption for the business owner and his/her team to minimize the impact on the business.
The scale of the interest was so high that we had to limit the prospects to a manageable number before we could schedule direct discussions with the owner. We accomplished this by establishing a minimum valuation floor and a set of expectations regarding deal terms and buyer characteristics.
Healthcare technology SaaS businesses, especially those with a recurring revenue business model, are seeing high valuation multiples in today’s market. Knowledgeable buyers are prepared for this, but new entrants in the market can get a serious case of “sticker shock.” Setting a valuation floor and then incrementally raising it, helped us select serious, knowledgeable prospects.
Once we reduced the prospect list to a manageable number, we conducted introductory conference calls between the prospects and David Baxter. The prospects were able to get a direct read from David on the business, his goals, and the future potential for the business and the market sector.
At the Austin Dale Group, we strive to find a win-win M&A agreement for our client and the other party, regardless of whether we are on the buy-side or the sell-side. Our decades of experience in the healthcare and technology industries lets us speak the same language with entrepreneurs and investors and to understand their needs and goals.
In negotiating a Letter of Intent (LOI), the first step is to listen to our client and the principal stakeholders on the other side of the transaction. We want to understand their motivations and key criteria to find a meeting point that works for both parties.
A well-constructed LOI can take a considerable amount of negotiation. We generally try to come to a high-level agreement in principle prior to negotiating an LOI. To accomplish this, we request participants submit indications of interest (IOIs) to select a handful of prospects with whom we will negotiate an LOI.
In the end, the ‘winner’ is the prospect whose LOI has the best blend of the key criteria that are most important to the seller.
The Due Diligence process can be tedious and time consuming for all parties, and it can involve a significant number of participants. Open communications and full disclosure are also critical for establishing trust between the parties.
The buyer had prior M&A experience and an experienced private equity partner to drive the Due Diligence process. Even with experienced parties, open communications, and a carefully crafted LOI, surprises can come up in Due Diligence.
In this case, during the quality of earnings review, our client was notified by his largest customer that they were being acquired by a larger entity, and that it was unclear if the acquirer would continue to use S3’s resupply services. At approximately the same time, Philips Respironics, one of the top two DME manufacturers, announced that it was recalling a large percentage of its sleep therapy machines due to a potential risk to patients.
These two market events were beyond the control of S3 and introduced a significant amount of uncertainty into the near-term business prospects and revenue forecast. Both parties decided to put the deal on hold until the market situation became more clear.
The delay lasted about nine months, at which time, the market situation improved, and we took S3 back to market with a group of prospects who had been serious contenders in the first round. We repeated the negotiation process and ended up with a better deal for the seller.
In the intervening months, S3 had proven its resiliency by replacing all of the revenue of their largest customer and by continuing to grow revenue and profitability.
The definitive sale agreement is generally negotiated in parallel with Due Diligence. Findings in the due diligence process can have a material impact on the final agreement terms and valuation.
The acquirer’s attorney usually takes the lead in drafting the definitive agreement. The Austin Dale Group collaborates with the attorneys on both sides and with the buyers and sellers during the definitive agreement negotiation. Since we have been involved from the outset, we generally have a better understanding of the business and the parties’ overall goals than do the attorneys. We also have an in-depth understanding of industry norms in M&A transactions.
In the S3 transaction, there were multiple parties who had to approve the deal terms. In addition to our client, the seller, there was the buyer organization, their private equity backer, and multiple institutional investors. All had to be satisfied with the due diligence outcome, especially the quality of earnings review, and the deal terms.
Key deal terms such as retained equity, seller financing, working capital, and earnout provisions must be negotiated in detail in the final stages of the deal. Where the seller will retain equity or provide other types of seller financing, the seller must do due diligence on the buyer to ensure that their investment will be secure and profitable over time.
The deal close is all about timing and coordination. Legal, financial, communications, and human resources all must be synchronized to affect the transfer of ownership. With S3, the biggest issue was the number of involved parties, which impacted the timing of the Close. The buyer was overly optimistic about the amount of time it would take to finalize the legal agreements and fund the transaction.
Close was about 45 days after the originally proposed date. As a seller, prepare to be patient with the close process, especially when multiple parties are involved, and understand that there are a lot of details to resolve.